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A P P R O V E D: A U G U S T 2 0 1 9

I N V E S T M E N T P O L I C Y,

GUIDELINES, AND PROCEDURES

EMPLOYEES’ RETIREMENT SYSTEM OF THE STATE OF HAWAII

EMPLOYEES’ RETIREMENT SYSTEM OF THE STATE OF HAWAII - INVESTMENT POLICY, GUIDELINES, AND PROCEDURES

TABLE OF CONTENTS

A. Introduction

B. ERS Plan Overview

1. ERS Plan Summary

2. Mission Statement

3. Statutes

4. Administration

5. Responsibilities of the Various Parties

6. Code of Ethics

7. Delegation of Authority

8. Conflicts of Interest

9. Operating Procedures

10. Trustee Education Policy

C. ERS General Investment Overview

1. ERS Investment Plan Summary

2. Investment Management Policy

3. General Investment Objectives and Guidelines

4. Manager “Watch List” or Termination Guidelines

5. Investment Meeting Policy

6. Reporting Requirements for Investment Managers

7. ERS Distribution of Brokerage Commission

8. Securities Lending Guidelines

9. Strategic Allocation Rebalancing Guidelines

10. Portfolio Transition Guidelines

11. Securities Litigation Guidelines

12. Responsible Investing

13. Policy for the Use of Placement Agents

14. Board of Trustees Discretionary Account Guidelines

D. Broad Growth Program

E. Principal Protection Program

F. Real Return Program

G. Hawaii Targeted Investment Program

H. Crisis Risk Offset Program

I. Opportunities Program

J. Implementation Overlay Program

Appendices

Appendix A Statutes

Appendix B Risk Factor Definitions

Appendix C Manager Style Groups

Appendix D Glossary of Investment Terms


SECTION A

I N T R O D U C T I O N

S E C T I O N: A


SECTION A PAGE | 1

A. Introduction

The purpose of this Investment Policy, Guidelines, and Procedures manual (“Manual”) is to provide the

Employees’ Retirement System of the State of Hawaii (“ERS” or “Plan”) with a comprehensive set of

guidelines for proper management of its investment decisions. The Board of Trustees of the ERS, in its role

as a fiduciary, is obligated to follow a procedurally prudent process when investing the Plan’s assets.

Fiduciary prudence is based on the conduct of the members of the Board of Trustees (“Trustees”) in

managing the Plan’s assets, and is evaluated by the process through which risk is managed, assets are

allocated, managers are chosen, and results are supervised and monitored.

Evolving legal standards have made clear the legal responsibility of fiduciaries to manage a plan’s assets

in a prudent manner, and the guidelines contained in this Manual are based on the relevant legislation and

regulations confronted by public pension funds. However, the guidelines go beyond simply outlining legally

prudent management of investment decisions–they are intended to assist the Trustees in achieving long-

term success in investing the Plan’s assets.

Success in this context is defined as achieving a long-term return that is needed in conjunction with actuarial

defined contributions to fund the plan over time and is reasonable through a fully diversified approach to

the capital markets without being too aggressive or conservative as to run the risk of under-achieving a

reasonable return.

Today’s prudence emphasizes fiduciary responsibility regarding the portfolio and its purpose, rather than

on the performance of the plan. Trustees as fiduciaries have the responsibility for the general management

of the Plan’s assets. They are responsible for setting and overseeing the implementation of the Plan’s

investment policy, but need not be investment managers or investment specialists and are not responsible

for the results of any single investment. Although it is not possible to guarantee investment success,

following the process outlined in this Manual will significantly improve the odds of structuring an

investment portfolio which will stand up to public scrutiny and benefit the Plan’s beneficiaries by providing

an acceptable long-run return.

This Manual, although comprehensive in its coverage, does not provide an in-depth analysis of all-

important issues, which Trustees must deal with when investing the Plan’s assets. It therefore should not

be viewed as the only “tool” required by the Trustees for prudent investment management, but rather as

one component of the Trustees’ “educational tool kit”, to be used in conjunction with continuing education

and the advice and services of investment consultants and investment managers.


SECTION B

P L A N O V E R V I E W

S E C T I O N: B


SECTION B

TABLE OF CONTENTS

Page

1. ERS PLAN SUMMARY ....................................................................................................................... 1

2. MISSION STATEMENT ....................................................................................................................... 1

3. STATUTES ............................................................................................................................................ 2

4. ADMINISTRATION ............................................................................................................................. 2

5. RESPONSIBLITIES OF THE VARIOUS PARTIES ........................................................................... 3

6. CODE OF ETHICS ................................................................................................................................ 9

7. DELEGATION OF AUTHORITY ........................................................................................................ 9

8. CONFLICTS OF INTEREST .............................................................................................................. 10

9. OPERATING PROCEDURES ............................................................................................................ 11

10. TRUSTEE EDUCATION POLICY .................................................................................................... 13


SECTION B PAGE | 1

B. 1. ERS Plan Summary

The Employees’ Retirement System of the State of Hawaii (“ERS” or “Plan”) was established by the

Hawai‘i legislature in 1925. The ERS provides retirement, disability and survivor benefits for employees

of the State of Hawai‘i (“State”) and its counties, including teachers, professors, police officers, firefighters,

judiciary employees, judges and elected officials.

Administration of the ERS falls under the policy and executive direction of a Board of Trustees, with certain

areas of administrative control vested in the State Department of Budget and Finance. The Board of Trustees

consists of eight members (“Trustees”): the State Director of Finance, ex officio; four members of the ERS

elected by the membership (two general employees, one teacher and a retiree); and three citizens of the

State who are not State or county employees and are appointed by the Governor, two of whom must have

at least three years of experience providing financial services, including investments, to public, corporate,

or private institutional clients.

The ERS is a tax-qualified governmental pension plan that meets the requirements of section 401(a) of the

Internal Revenue Code. As such, the ERS is exempt from federal income taxation on its investment

earnings. Since January 1, 1988, member contributions have been tax deferred under Section 414(h) of the

Internal Revenue Code.

The ERS has both contributory and noncontributory benefit structures, or “plans.” ERS members in the

contributory plans are required to make contributions to the ERS and may also be covered by Social

Security. The ERS’s original benefit structure was a contributory plan. Members of certain occupational

groups are required to be members of the original contributory plan. The original contributory plan also

includes employees hired before July 1, 1984, who did not elect to join the noncontributory plan, which

was established effective July 1, 1984. A new contributory plan (known as the “hybrid plan”) was

established effective July 1, 2006. Most employees hired after June 30, 2006, as well as employees hired

before July 1, 2006, who elected to join the hybrid plan, are members of the hybrid plan.

Members of the noncontributory plan do not make contributions to the ERS and must be covered by Social

Security. The noncontributory plan includes most employees hired between July 1, 1984 and July 1, 2006,

as well as employees hired before July 1, 1984, who elected to join the noncontributory plan and did not

transfer to the hybrid plan.

B. 2. Mission Statement

The mission of the ERS is to provide superior services to members in a cost-effective manner through

qualified personnel while maintaining the highest ethical standards. The mission will be accomplished by

ERS in cooperation with the Board of Trustees and the ERS staff through the following objectives:

Exemplary Service To provide accurate, courteous, and prompt service to ERS members.

Benefit Standards To provide retirement, disability, and survivor benefits for State and county

employees.

Funding Standards To provide for the long-term funding of ERS on an actuarial basis so that sufficient

assets will be accumulated to pay for the statutory benefits of current and future

retirees.

Staffing To attract and retain professional, highly trained staff in an atmosphere conducive

to innovation, challenges, and a high level of performance.


SECTION B PAGE | 2

Research To continuously perform studies on pension issues and to compare the ERS with

other public and private pension systems.

Management To manage by leading, planning, organizing, and controlling ERS operations in a

cost effective manner for the benefit of ERS members and State and county

taxpayers, utilizing personnel, technology and capital efficiently, while providing

the highest level of service.

Ethical Standards To maintain the highest ethical standards.

Investment Return To obtain a reasonable return on investments consistent with the preservation of

principal, while maintaining sufficient liquidity to react to the changing

environment and to pay benefits when due.

B. 3. Statutes

The primary statute pertaining to ERS investments is Section 88-119, Hawai‘i Revised Statutes (“HRS”).

Section 88-119, HRS, and other statutes pertaining to ERS investments are included in this Manual in

Appendix A.

B. 4. Administration

Provisions pertaining to the administration of the ERS are contained in Chapter 88, HRS, and Title 6

(Department of Budget and Finance), Chapters 20-29 (Employees’ Retirement System), Hawai‘i

Administrative Rules. An organization chart of the ERS is shown below

Board of Trustees

Chief Investment

Officer

Risk Manager

Liquid Markets Officer

Illiquid Markets Officer

Operations

Deputy Executive Director

Accounting Branch

Enrollment Claims &

Benefits Branch

Information Systems

Mortgage Services

Staff Support Services

Executive Director


SECTION B PAGE | 3

B. 5. Responsibilities of the Various Parties

The principal parties include: Board of Trustees

Investment Staff

Actuary

Legal Counsel

Bank Custodians

General Investment Consultant

Real Estate Consultant

Private Equity Consultant

Investment Managers

GENERAL RESPONSIBILITIES

Board of Trustees

Main Responsibilities

Pursuant to Chapter 88, HRS, the general administration of the ERS is vested in the Board of

Trustees of the ERS (the “Board of Trustees” or “Board”).

Responsible for setting investment policies and determining the strategic allocation of investments

through the formulation of investment guidelines.

Maintains overall responsibility for financial management of the Plan.

Appoints the Executive Director of the ERS (“Executive Director”) and the Chief Investment

Officer of the ERS (“CIO”).

Selects the ERS’s actuaries (“Actuary” or “actuary”), bank custodians (“Custodian” or

“custodian”), investment managers (“Investment Managers” or “investment managers”) and

investment consultants (“Investment Consultants” or “investment consultants”) and determines

specific duties, authority, responsibilities, fiduciary status, and forms and amounts of compensation

of each.

Monitors and evaluates the Actuary, Custodian, Investment Managers and Investment Consultants,

as well as the results of the Plan’s investments.

Reviews and approves strategic and tactical plans developed by ERS investment staff (“Investment

Staff”), Investment Consultants, and/or Investment Managers.

Monitors the portfolio’s development and performance through quarterly performance reports

presented by the Investment Consultants.

The Board of Trustees has formed an Investment Committee to review new investment proposals.

Each Trustee is responsible for obtaining and maintaining the necessary training and education

required to carry out his/her duties at the ERS. It will be necessary for the Trustees to travel to

industry conferences and participate in educational forums as opportunities arise.


SECTION B PAGE | 4

Investment Staff (managed by the Chief Investment Officer)

The Investment Staff carries out the investment administration of the Plan on behalf of the Board of Trustees

and is directly responsible to the Board of Trustees.


The Investment Staff should receive the necessary training and education required to carry out their

duties at the ERS. It will be necessary for Investment Staff to travel to industry conferences

and participate in educational forums as opportunities arise.

Responsible for the oversight of ERS’s investment portfolio. Monitors and oversees the ERS’s

external investment managers and the internal investment portfolio.

Responsible to evaluate, and to consult with the applicable investment consultant, as necessary,

regarding, requests for action related to the investment portfolio and to make a recommendation to

the Executive Director with concurrence from the applicable investment consultant regarding the

appropriate response to the request, including, whether the requested action requires express

consent from the Board. If the Executive Director determines that the Board’s consent is not

required for the response, the CIO is responsible for reporting the Investment Staff level response

to the Board of Trustees.

Meets with Investment Managers to review performance and to monitor compliance with

investment policies and procedures, and contractual guidelines.

Together with the applicable Investment Consultant: (i) develops search criteria for investment

mandates under consideration by the Board and (ii) evaluates and selects a short-list of investment

manager finalist(s) for each mandate under consideration; negotiates fees and contracts; and

recommends the termination of investment managers if necessary.

Develops search criteria for Investment Consultants; participates in the evaluation and selection of

investment consultants; and recommends termination of investment consultants if necessary.

Oversees security lending programs.

Formulates, evaluates, recommends and implements investment policies and procedures for all

strategic classes. Conducts ongoing review and maintains the Manual.

Monitors performance benchmarks, risk characteristics and performance attribution analysis for the

broad investment portfolio, strategic classes and individual investment managers.

Implements long and short-term strategic allocation strategic plans. Develops programs to

efficiently implement strategic allocation decisions, including securities trading and cash

management.

Develops search criteria, evaluates and participates in the selection of asset transition management

firms.

Advises the Board on a quarterly basis of cash flow requirements and the availability of funds for

investment.

Assists the Board with coordinating responsibilities/projects amongst the applicable investment

consultants and investment managers.

Develops and implements investment education and training programs for the Board and

Investment Staff.

Reviews proposed legislation on matters dealing with the ERS’s investment programs. Drafts

legislative proposals, testimonies and administrative rules.


SECTION B PAGE | 5

Actuary

The Actuary is hired by, and responsible to, the Board of Trustees. However, the Board of Trustees does

not have direct control over the work of the Actuary, because the studies do not involve any discretion but

rather are based on the “facts” of the Plan and standard actuarial procedures.


Measures and evaluates the actuarial soundness of the Plan on an annual basis.

Provides actuarial values for the asset/liability study.

Performs actuarial studies as requested by the Board of Trustees.

Reviews proposed legislation and provides estimates of the cost impact of the proposed legislation.

Performs actuarial evaluations to determine the annual State and county contributions to fund the

ERS.

Legal Counsel

The Attorney General of the State of Hawai‘i (“State Attorney General”) serves as the legal adviser to the

Board of Trustees.

Bank Custodian

The Custodian is hired by, and responsible to, the Board of Trustees.


Provides a monthly reconciliation of ERS assets between the bank’s records and each investment

manager’s statement.

Provides safekeeping and custody of all securities purchased by managers on behalf of the Plan.

Provides for timely settlement of securities transactions.

Maintains short-term investment vehicles for investment of cash not invested by managers.

Checks all investment manager accounts daily to make sure that all available cash is invested.

Collects interest, dividend and principal payments on a timely basis.

Processes corporate actions.

Files and monitors class action settlements on behalf of ERS.

Prices all securities at least on a monthly basis, preferably on a daily basis contingent on strategic

class and types of securities.

Manages a securities lending program.

Generally provides data and reports directly to the ERS and service providers on a regular basis.

Provides monthly, quarterly and annual reports.

Values and monitors derivatives and the trades from which they emanate.

Provides continuing education programs for the Board of Trustees and Investment Staff.

Provides a daily compliance report to Investment Staff for ERS public markets managers.


SECTION B PAGE | 6

General Investment Consultant

The role of the general investment consultant (“General Investment Consultant”) is to provide objective,

independent third-party advice to the Board of Trustees. A General Investment Consultant does not have

discretionary decision-making authority on behalf of the Board of Trustees. The General Investment

Consultant functions in a research, evaluation, education, and due diligence capacity for the Board of

Trustees and maintains a fiduciary responsibility for the quality of the service delivered. General Investment

Consultants are identified and hired by, and provide advice and services to, the Board of Trustees.


Recommends strategic procedures and processes.

Upon the request of the Board of Trustees, prepares a strategic allocation study.

Assists with investment manager structure, selection, monitoring and evaluation.

Measures and evaluates the overall performance of the portfolio.

Carries out special projects at the request of the Board of Trustees and Investment Staff.

Provides continuing education to the Board of Trustees and Investment Staff.

As deemed appropriate by Investment Staff and the general investment consultant, sources and

conducts due diligence on prospective investments.

Real Estate Consultant

The role of the real estate consultant (“Real Estate Consultant”) is to provide objective, independent third-

party advice to the Board of Trustees. A Real Estate Consultant does not have discretionary decision-

making authority on behalf of the Board of Trustees. The Real Estate Consultant functions in a research,

evaluation, education, and due diligence capacity for the Board of Trustees and maintains a fiduciary

responsibility for the quality of the service delivered. Real Estate Consultants are identified and hired by,

and provide advice and services to, the Board of Trustees.


Recommends strategic procedures and process.

Develops the annual core and non core real estate strategic plans with input from Investment Staff

and the general investment consultant.

Oversees the implementation of the separate account tactical plan process.

Assists with investment manager structure, selection, monitoring and evaluation.

Measures and evaluates the overall performance of the core and non core real estate programs.

As requested, represents the ERS as a member of advisory boards for commingled funds.

Available to administer required portfolio level control and monitoring systems.

Carries out special projects at the request of the Board of Trustees and Investment Staff.

Provides continuing education to the Board of Trustees and Investment Staff.

Private Equity Consultant

The role of the private equity consultant (“Private Equity Consultant”) is to lead the implementation of the

private equity program. The Private Equity Consultant maintains a certain level of discretionary decision-

making authority on behalf of the Board of Trustees. The Private Equity Consultant operates in a variety of

capacities for the Board of Trustees including: education, evaluation, sourcing, selection, fiduciary, and


SECTION B PAGE | 7

implementation. Private Equity Consultants are identified and hired by, and provide advice and services to,

the Board of Trustees.


Leads implementation of the private equity program.

Develops the annual strategic plan with input from Investment Staff and the general investment

consultant.

Recommends use of specialty investment managers, if applicable.

Sources and conducts due diligence on prospective investments.

Maintains dialogue with Investment Staff regarding the investment pipeline and due diligence.

Completes an investment disclosure form and submit to Investment Staff for review prior to closing

into a prospective investment.

Acts as a fiduciary regarding investment discretion and advice.

Measures and evaluates the overall performance of the private equity portfolio.

Investment Managers

The role of Investment Managers is to manage assets, within a specified mandate, on behalf of the ERS.

The specific relationship (including, for example, fees, investment restriction, etc.) between each

Investment Manager and the Board of Trustees is outlined in the investment management or manager

agreement between the specific Investment Manager and the Board of Trustees.


Acts as a “prudent expert” on behalf of the Board of Trustees.

Develops a portfolio strategy within the specific mandate and asset size determined by the Board

of Trustees.

Manages, purchases, and sells assets for the portfolio in accordance with their assigned portfolio

mandate.

Acts as fiduciary for assets under their management.

Fiduciary Responsibilities

Board of Trustees

The duties and responsibilities of the Board of Trustees are governed and limited by Hawai‘i statutes and

laws. In the past, the Board of Trustees has also looked to general trust law, such as outlined by the Third

Restatement, Trusts, for guidance as to its duties and responsibilities regarding the investment of ERS

assets. In connection with the foregoing, the Board of Trustees has adhered to the following:

1. Except as otherwise provided by law, administer ERS investments solely in the interest of Plan

participants.

2. Prepare written investment policies and documents the process. In doing so the Trustees must:

* Determining the Plan’s missions and objectives.

* Choosing an appropriate strategic allocation strategy.

* Establishing specific investment policies consistent with the Plan’s objectives.

* Selecting investment managers to implement the strategic allocation.


SECTION B PAGE | 8

3. Diversify assets with regard to specific risk/return objectives for the participants/beneficiaries.

4. Use “prudent experts” to make investment decisions.

5. Control investment expenses.

6. Monitor the activities of all Investment Staff, investment managers, and investment consultants.

7. Avoid conflicts of interest.

The Board of Trustees and Investment Staff should regularly undertake continuing education relevant for

their duties. Specifically, all Trustees and key Investment Staff should participate in an educational

programs, which provide basic instruction on the four primary components of the investment management

process:

1. Fiduciary responsibility and procedural process.

2. Developing investment policy guidelines and designing investment manager structures.

3. Implementing investment policies.

4. Evaluating and controlling an investment program.

Statutory Protection for Trustees

Section 26-35.5, HRS, is applicable to members of boards and commissions, including the Trustees. As it

pertains to the Trustees, Section 26-35.5 generally protects Trustees from being personally liable in civil

actions for damages or loss resulting from acts or omissions in their capacity as a Trustee unless the

individual acts with a malicious or improper purpose.

More specifically, Section 26-35.5(b), HRS, states that:

Notwithstanding any law to the contrary, no member shall be liable in any civil action founded

upon a statute or the case law of this State, for damage, injury, or loss caused by or resulting from

the member’s performing or failing to perform any duty which is required or authorized to be

performed by a person holding the position to which the member was appointed, unless the member

acted with a malicious or improper purpose, except when the plaintiff in a civil action is the State.

Section 26-35.5(c), HRS, describes the situations in which Trustees will be indemnified by the State in civil

actions arising under federal law, the laws of another state, or the law of a foreign jurisdiction.

Section 26-35.5, HRS, also contains subsections describing when indemnification is not available and when

the State Attorney General will provide representation.

Consultants (Actuary, Investment Consultants, and other Service Providers)

The ERS’s consultants, including the Actuary, Investment Consultants and other service providers, have a

fiduciary responsibility for the services they are contracted to provide to the ERS. Investment Consultants

are not Plan fiduciaries if they have no discretion over the assets or any decision-making authority. They

do, however, have fiduciary responsibility for the quality and accuracy of any service, report information,

or recommendations made to the Trustees or Investment Staff. Investment Consultants are Plan fiduciaries

if they have discretion over the assets or any decision-making authority. Additionally, Investment

Consultants with discretion have fiduciary responsibility for the quality and accuracy of any service, report

information, or recommendations made to the Trustees or Investment Staff.


SECTION B PAGE | 9

Bank Custodian

The Custodian’s fiduciary responsibility shall involve the proper safekeeping, valuation, pricing,

accounting and reporting of Plan assets across multiple investment manager portfolios and strategic classes.

As co-fiduciary to the Plan, the Custodian shall apply investment prudence to short term cash management

and securities lending functions.

Investment Managers

Investment Managers have a fiduciary responsibility for the assets placed under their discretion.

B. 6. Code of Ethics

Trustees and Staff

The State Code of Ethics is contained in Chapter 84, HRS. The State Code of Ethics applies to Trustees

and to all ERS employees, including Investment Staff. The State Code of Ethics includes the following

requirements and prohibitions:

1. Trustees and ERS employees may not solicit or accept gifts that will influence the performance of

their duties.

2. Trustees, ERS employees, former Trustees and former ERS employees may not disclose

confidential ERS information or use confidential ERS information for their personal gain or the

benefit of anyone else.

3. Trustees and ERS employees may not use their ERS position to secure unwarranted privileges for

themselves or others.

4. Trustees and ERS employees must disqualify themselves from making any decision or

recommendation on a matter in which they have a substantial financial interest.

5. Trustees and ERS employees may not, within twelve months after leaving an ERS position,

represent a person or organization for compensation on ERS matters.

Trustees and Staff are responsible for familiarizing themselves with the requirements of the State Code of

Ethics and for adhering to the provisions of the Code.

B. 7. Delegation of Authority

Under general trust law, trustees may, and for many purposes do, delegate authority to properly selected

and supervised agents. The Board has statutory authority to hire investment advisors. Consistent with

generally accepted fiduciary standards referenced in this Manual, while the Board of Trustees is able to

delegate authority concerning the buying and selling of securities and other investments, they may not

totally abdicate their fiduciary responsibilities. The duty of prudence requires that the Board of Trustees

establish parameters and guidelines for investment, set controls to be maintained, and monitor the

performance of the investment advisors.


SECTION B PAGE | 10

B. 8. Conflicts of Interest

Trustees and Staff

Section 84-14, HRS, entitled “Conflicts of Interests,” is part of the State Code of Ethics. Section 84-14

applies Trustees and Investment Staff. In part, Section 84-14 prohibits Trustees and Investment Staff from

taking any official action directly affecting a business or other undertaking in which the Trustee or

Investment Staff member has a substantial financial interest, or directly affecting a private undertaking in

which the Trustee or Investment Staff member is engaged as legal counsel, adviser, consultant,

representative or agent capacity. The State Ethics Commission has issued an “Ethics Guide for Elected

Officials, Employees, Members of Boards and Commissions.” The main points from this Guide are:

1. Trustees must act in good faith and not allow their personal interests to prevail over the interest of the

ERS.

2. Trustees shall conduct themselves so as to avoid even the appearance of any illegal or unethical conduct,

and shall at all times do their utmost to carry out their duties with courtesy and in a professional manner.

3. Trustees should exclude themselves from discussions and/or votes the results of which would or could

affect that person’s immediate family, or any other entity in which that person has an ownership or

other financial interest.

4. If a Trustee is not sure whether his/her interest constitutes a conflict, such Trustee shall fully disclose

his/her interest and the Board should refer the matter to the State Attorney General or State Ethics

Commission for advice. Until an advisory is issued, the Trustee should exclude himself/herself from

discussions and/or voting on the matter in question.

5. Trustees shall disclose before the discussion of the issue any conflict or possible conflicts of interest.

The Trustee shall recluse himself/herself from participating in any discussion, votes, or other decision

making on the matter. The recording secretary shall note for the minutes the Trustee’s disclosure.

All Consultants and Investment Managers

The Board of Trustees requires that Investment Consultants and Investment Managers adopt policies to

avoid actual or even perceived conflicts of interest by disclosing any potential conflicts. Failure of

Investment Managers to disclose a conflict of interest in managing assets is grounds for watch list status

and eventual termination. Similarly, the Trustees require that Investment Consultants disclose all business

activities and relationships that could be perceived as potential conflicts of interest on an annual basis.

Specifically, the Investment Consultants shall disclose annually any business relationships with current

ERS Investment Managers, the services provided in these relationships, and the compensation earned from

the Investment Manager for these services. Additionally, at the time of an investment manager search, any

business relationships with the investment managers being considered must be disclosed. ERS also expects

that its Investment Managers and Investment Consultants adhere to a firm-wide ethical code that explicitly

seeks to avoid any conflicts of interest in order to ensure the highest possible honesty and integrity in the

services that these firms provide to the Plan.


SECTION B PAGE | 11

Private Markets Consultants and Private Markets Managers

Proprietary Products – In private markets, there may be situations wherein an Investment Consultant or

Investment Manager may recommend its proprietary investment product(s) for investment. Under such

circumstances, certain conflicts of interest could arise. To address this issue, the Consultants/Managers

involved must present an appropriate resolution that addresses the potential conflict of interest to the Board of

Trustees. Such solutions might include (i) re-directing the due diligence of proprietary products to another

consultant/advisor or specialty manager, (ii) re-directing the asset allocation decision linked to the proprietary

product to another consultant/advisor or specialty manager, and/or (iii) a combination of above, or other

reasonable approaches. Any proprietary investment must be approved in advance by the Board of Trustees.

Allocation of Investments among Accounts – There may be instances where the Investment Manager will need

to allocate an investment opportunity among a number of clients or a competing product (e.g., fund-of-funds

or commingled funds). Suitable protective covenants or processes for resolving conflicts in allocation among

accounts will be incorporated in the investment management agreement. The Investment Manager, as a prudent

expert and fiduciary, will seek to ensure that appropriate and equitable allocation and pricing occurs with

respect to the ERS’s portion of any manager-apportioned investment.

Personal Investments – Investment Consultants’ employees and Investment Managers’ employees are

permitted to invest personally or otherwise have beneficial interest in investments held on behalf of clients such

as the ERS, only upon the ERS first securing a full and appropriate allocation. Each Investment Consultant and

Investment Manager will provide the ERS with its policies for personal investments by employees as an

attachment to its investment consultant or investment management agreement, and notify the Investment Staff

and general investment consultant of any changes in those policies.

Other Conflicts of Interest – When and if other conflicts of interest become apparent, suitable protective

covenants or processes for resolving conflicts will be incorporated into the investment consultant and

investment management agreements.

B. 9. Operating Procedures

Meetings

1. All regular meetings shall be held on the second Monday of each month unless otherwise agreed

upon by the Trustees. The schedule for the regular meetings shall be reviewed by the Trustees each

January.

2. All special meetings shall be on days agreed upon by the Trustees.

Agenda

1. Deadline for requesting matters to be placed on the agenda for regular meetings by a Trustee,

Deputy Attorney General, and/or Executive Director shall be by 12:00 noon, seven (7) calendar

days prior to the meeting date. Should the seventh day fall on a holiday, the last working day

preceding the holiday shall be the deadline.

2. Deadline for requesting matters to be placed on the agenda for special meetings by a Trustee,

Deputy Attorney General, and/or Executive Director shall be 12:00 noon, seven (7) calendar days

prior to the meeting date. Should the seventh day fall on a holiday, the last working day preceding

the holiday shall be the deadline.


SECTION B PAGE | 12

3. The final composition of the agenda shall have the approval of the Chair of the Board of Trustees.

4. A Trustee, Deputy Attorney General, and/or Executive Director wishing to place matters on the

agenda after the deadline has passed, must have copies of the subject material available to the

Trustees when the meeting convenes with a note indicating that he or she will be requesting that

this matter be placed on the agenda. (A minimum of six (6) Trustees must be present to put matters

on the agenda - Sections 92-7(d) and 88-24, HRS.)

Material

1. All regular meeting material shall be in the hands of the Trustees no later than Wednesday prior to

the meeting date.

2. All special meeting material shall be in the hands of the Trustees no later than four (4) calendar

days prior to the meeting date.

3. All Trustees who will not be on the island to receive their material will inform the Executive

Director as soon as possible so other arrangements can be made.


SECTION B PAGE | 13

B. 10 Trustee Education Policy

Preface

The Board of Trustees recognizes its role in the general administration and proper operation of the

retirement system. In order to discharge their duties in a prudent and reasonable manner, the Trustees

should possess basic knowledge and understanding of the component functions of the retirement system,

including without limitation, statutory and regulatory requirements, financial management, investments,

retirement benefits, audit, legislative, and fiduciary oversight. The Trustee Education Policy provides a

framework and process for ensuring that the Trustees - both individually and collectively - are provided the

knowledge and education required to fulfill their responsibilities to the retirement system.

Administration

The Executive Director (or designee) is responsible for fulfillment of the Trustee Education Policy by

implementing the following:

1. Identify Trustee educational needs, including without limitation, statutory and regulatory

requirements, ERS policies and practices, investments, pension plan management,, and fiduciary

responsibility.

2. Develop a Trustee Education Plan (TEP) for each individual Trustee to include at least one

educational opportunity per year.

3. Present the appropriate educational information or opportunities to the Trustees as they are

available including those offered by industry organizations, conference organizations, academic or

industry institutes, and colleges and universities.

4. Upon approval of the Board of Trustees, assist the Trustees with registration and travel approvals,

as required.

5. Coordinate the presentation of Trustee post-education summary reports to the Board of Trustees

within three months of completion of the educational opportunity.

6. Monitor and update the TEP on a continual basis.

7. Report the status of the TEP to the Board of Trustees on an annual basis.


SECTION C

G E N E R A L I N V E S T M E N T O V E R V I E W

S E C T I O N: C


SECTION C

TABLE OF CONTENTS

Page

1. ERS INVESTMENT PLAN SUMMARY ............................................................................................ 1

2. INVESTMENT MANAGEMENT POLICY ........................................................................................ 3

3. GENERAL INVESTMENT OBJECTIVES AND GUIDELINES ....................................................... 6

4. MANAGER “WATCH LIST” OR TERMINATION GUIDELINES .................................................. 6

5. INVESTMENT MEETING POLICY.................................................................................................... 9

6. REPORTING REQUIREMENTS FOR INVESTMENT MANAGERS ........................................... 11

7. ERS DISTRIBUTION OF BROKERAGE COMMISSION .............................................................. 13

8. SECURITIES LENDING GUIDELINES ........................................................................................... 14

9. STRATEGIC ALLOCATION REBALANCING GUIDELINES...................................................... 22

10. PORTFOLIO TRANSITION GUIDELINES ...................................................................................... 24

11. SECURITIES LITIGATION GUIDELINES ...................................................................................... 26

12. RESPONSIBLE INVESTING ............................................................................................................. 28

13. POLICY FOR THE USE OF PLACEMENT AGENTS ..................................................................... 37

14. BOARD OF TRUSTEES DISCRETIONARY ACCOUNT GUIDELINES ..................................... 40


SECTION C PAGE | 1

C. 1. ERS Investment Plan Summary

Type of Plan Defined Benefit

June 30, 2018 $16.5 Billion

Investment Planning Time Horizon 5 years

Expected Annualized Return and Risk

Based on the 2015 Asset-Liability Study, the target

allocation is expected to achieve an average annualized

return of 7.8% (4.8% real return with expected inflation of

3.0%). The annual compound return over a ten-year

period is expected to fall within a range of 4.9% and

10.7% approximately two-thirds of the time.

Primary Goal

The preservation of capital is of primary concern of the Employees’ Retirement System of the State of

Hawaii (“ERS” or “Plan”). The Board of Trustees of the ERS (“Board of Trustees” or “Board”) seeks

preservation of capital with a consistent, positive return for the Plan. Although pure speculation is to be

avoided, the Board appreciates the fact that an above average return is associated with a certain degree of

risk. Risk to be assumed must be considered appropriate for the return anticipated and consistent with the

total diversification of the Plan.

Structure

During 2014, the ERS adopted a risk-based, functional framework for allocating capital within the total

portfolio. This framework makes use of strategic/functional classes that in-turn utilize underlying asset

classes and strategies. Each of these classes is designed to achieve a certain goal (e.g., Real Return class)

and/or be exposed to a specific set of macroeconomic risks that are common amongst the different strategy

types and/or assets within the class (e.g., Broad Growth class). As a result of this structure, each strategic

class is expected to be exposed to a set of major and minor macroeconomic risks. Each program's policy

section contains a list of the relevant macroeconomic risks. Definitions for each of these macroeconomic

risks can be found in Appendix B of this Manual.

Evolving Strategic Allocation Targets

As a result of the 2015 Asset-Liability Study conducted by the ERS Board, Investment Staff, and general

investment consultant, the ERS approved a new long-term strategic allocation policy. This new long-term

strategic allocation policy will be implemented in phases as highlighted in the table below.

Implementation Plan for Long-term Policy

Current

(1/1/2019) 1/1/2020

Long-Term

7/1/2020

Broad Growth 68% 64% 63%

Principal Protection 8% 7% 7%

Real Return 8% 9% 10%

Crisis Risk Offset 16% 20% 20%

Opportunities 0% 0% 0%

Total Portfolio 100% 100% 100%


SECTION C PAGE | 2

Interim Strategic Allocation Target (1/1/2019 – 12/31/2019)

The ERS will be invested according to the following strategic class targets and ranges:

Interim Lower Limit Strategic Allocation Upper Limit






The Chief Investment Officer of the ERS (“CIO”) may set the actual class levels anywhere within the upper

and lower limits above. For deviations in excess of +/- 3%, the CIO shall provide regular ongoing

justifications for the deviations. Adjustments in the above targets may be reviewed in conjunction with the

annual strategic allocation review. The general investment consultant should conduct a formal strategic

allocation study at least every three years for the Board of Trustees to verify or amend the strategic targets

and ranges.

Total Investment Portfolio Evaluation Benchmark

To monitor the total investment portfolio result, a custom benchmark is constructed to measure the target

mix. This target benchmark mix will evolve over time, but it is based on the above-highlighted evolving

allocation targets and the broad benchmarks listed below (i.e. evolving weights x benchmark return).

Broad Growth Blended Benchmark*

Principal Protection Blended Benchmark*

Real Return Benchmark: CPI + 3%

Crisis Risk Offset Blended Benchmark*

Individual ERS investment managers (“Investment Managers” or “investment managers”) will not be

measured against this total investment portfolio objective. However, it is expected that the sum of their

efforts will exceed the objective over time.

*Refer to program section for detailed description of benchmark, and possible evolving benchmark timeline

Broad Growth68%

Crisis Risk Offset16%

Principal Protection

8%

Real Return8%

Opportunities0%


SECTION C PAGE | 3

C. 2. Investment Management Policy

A. Guidelines for Manager Selection

The Board will select appropriate investment managers to manage the ERS’s assets. This

selection process shall include the establishment of specific search criteria, and

documentation of analysis and due diligence on potential candidates. All manager

candidates must meet the following minimum criteria:

(1) Be a bank, insurance company, investment management company, or investment

adviser as defined by the Registered Investment Advisers Act of 1940.

(2) Provide historical quarterly performance numbers calculated on a time-weighted

basis, based on a composite of all fully discretionary accounts of similar investment

style, and reported net and gross of fees.

(3) Within the manager selection process, performance evaluation reports prepared by an

objective third party that illustrate the risk/return profile of the manager relative to

other managers of like investment style shall be reviewed.

(4) Provide detailed information on the history of the firm, key personnel, key clients, fee

schedule, and support personnel and demonstrate financial and professional staff

stability.

(5) Clearly articulate the investment strategy that will be followed and document that the

strategy has been successfully adhered to over time.

(6) Have a reasonable and competitive fee structure.

(7) Selected firms shall have no outstanding legal judgments or past judgments that

reflect negatively upon the firm to the extent that in the Trustees judgment they would

impair the ability of the firm to provide expert investment management to the ERS.

(8) With respect to real estate advisors, the ERS shall enter into contractual arrangements

only with organizations whose principal officers are engaged in the business of

advising and evaluating commercial, industrial or residential real estate investments,

mortgage banking, or property management, and which are duly licensed to perform

real estate advisor services in the jurisdiction where the real property is located.

All investment manager candidates are expected to comply with all laws, regulations, and

standards of ethical conduct.


SECTION C PAGE | 4

B. Manager Discretion

The investment managers shall be given full discretion to manage the assets under their

supervision subject to this Investment Policy, Guidelines, and Procedures manual

(“Manual”), their assigned mandate, the laws of the State of Hawai‘i (“State”), and their

investment management agreements with the ERS. All transactions effected for the ERS’s

investments will be subject to best price and execution.

The investment program will be managed by designated professionals/firms in regard to

both public and private securities, and investment managers will execute their mandates

consistent with the strategic allocation and mandate-specific objectives set forth by the

Board. Investment managers have no responsibility for the ERS’s aggregate strategic

investment allocation.

C. Manager Evaluation

Individual investment managers will be measured against an appropriate index and peer

group. Market indices and peer group benchmarks are assigned to each manager and are

intended as a guide for the investment manager to understand the risk/reward posture of

their portfolio. Investment managers have full discretion to manage the risk posture of their

portfolios relative to their designated market index and may, with conviction and

appropriate expertise, execute security strategies not reflected by their market index as long

as they conform to the investment guidelines and the laws of the State of Hawai‘i.

There shall be a continual review of the investments under management. The Board shall

confer with the investment managers to review the ERS’s investments and the current

environment. Each investment manager shall report pertinent data relating to the ERS

portfolio as stipulated in the Reporting Requirements section of their guidelines.

D. Policy on Local Managers

The Board of Trustees wishes to utilize qualified local firms in the management of a portion

of the ERS’s assets. Due to the size of the ERS’s portfolio and the fiduciary responsibility

of the board members to select qualified firms in accordance with overall Board investment

strategy, the following guidelines have been established for the identification, selection and

evaluation of Hawai‘i-based investment management firms.

(1) It shall be the policy of the Board to allocate assets to local investment managers

in accordance with the Board’s strategic allocation and long term investment

policies.

(2) The asset mix of the combined local investment managers’ portfolios shall be

determined under a fiduciary framework with respect to the overall portfolio and

relevant strategic classes.

(3) Investment Staff will maintain files and data on Hawai‘i-based firms that they are

made aware of through known contacts, conferences, consultants, etc.


SECTION C PAGE | 5

(4) As a guide for inclusion of a local investment manager in a Board-initiated search,

staff/consultant may use some of the following qualifications in the screening of

local firms:

a) One year of operation as an SEC registered investment management

firm.

b) The portfolio manager handling the account must have a minimum of

seven years of experience in investment management.

c) The firm must have a minimum of $50 million in total assets under

management and at least $25 million in the style/product designated

for the search.

d) The firm must have at least three tax-exempt client(s).

e) The senior principal must have at least two years experience in

running an investment management operation, either at the present or

a predecessor firm.

f) An acceptable and verifiable historical track record of at least three

years (a prior firm’s record is acceptable), which could have been

reasonably achieved by the manager’s current staff and resources.

Local managers are not required to be in conformance with CFA

Institute Standards.

g) Ownership or an equivalent stake in the firm by the active investment

management professionals.

h) A sound and convincing investment management process.

i) An adequate staff to support the investment, administrative and

regulatory functions.

(5) Evaluation of Local Firms

a) All local firms retained by the Board of Trustees shall be evaluated in

a similar fashion as all other investment managers within the same

strategic class.

E. New Investment Proposals

All new investment proposals presented to the ERS are initially reviewed and analyzed by

the Investment Staff (as directed by the CIO). Investment Staff will determine if the

proposal(s) should be considered further.

If the investment proposal warrants further consideration, Investment Staff shall conduct a

due diligence process utilizing the applicable investment consultant(s). After completion

of the due diligence process, the CIO will take his findings to the Investment Committee.

Upon review, the Investment Committee will direct the CIO to do one of three things: (1)

decline the investment proposal; (2) investigate the investment proposal further; or (3)

present the investment proposal to the Board of Trustees for approval.

Upon review, the Board of Trustees will decide one of the following: (1) decline the

investment proposal; (2) direct the CIO to investigate the investment proposal further; or

(3) approve the investment proposal.

The Board of Trustees makes the final decision on all new investment proposals.


SECTION C PAGE | 6

C. 3. General Investment Objectives and Guidelines

Investments will be prudent and consistent with the best investment practices, in accordance with

the assigned investment mandate, and in compliance with Chapter 88, HRS.

Currently, the ERS separates its investments into a series of four strategic programs; Broad Growth,

Principal Protection, Real Return, and Crisis Risk Offset. Each strategic program has a

corresponding section within this Manual. The strategic program sections are designed as

complete, and nearly autonomous, sections for the operation of each program within the total

portfolio. These sections contain goals, objectives, and guidelines for each program as a whole, as

well as for the underlying managers within each strategic program.

The Board recognizes that commingled funds’ guidelines are established by their trust

documents/prospectuses and that ERS guidelines have no bearing on the policies of commingled

funds. However, the Board expects that any manager of a commingled fund and/or index funds

will inform the Board if the investment policy of any such fund conflicts with any provisions of

this Manual.

C. 4. Guidelines for Manager “Watch List” or Termination

The performance of all investment managers will be monitored on an ongoing basis. The Trustees

may place a manager on a “Watch List” or terminate a manager at any time.

Investment managers may be terminated or placed on a “Watch List” for a variety of reasons:

personnel changes, violation of policy and investment guidelines, style deviations,

underperformance, strategic allocation changes and non-disclosure of material information. The

ERS has two clearly stated investment portfolio performance objectives; the preservation of capital

and consistent positive returns. These “Watch List”/termination guidelines were formulated with

these objectives as a foundation. There are various factors that should be taken into account when

considering placing a manager on a “Watch List” or the termination of a manager. These can be

separated into two broad categories - qualitative and quantitative factors. The former focuses on

personnel, organizational and legal issues while the latter addresses performance.

When possible, the Board will issue a warning letter to underperforming investment managers prior

to placement on the “Watch List”. However, the Board may place a manager on the “Watch List”

at any time whether or not a warning letter has been issued. Placing a manager on the “Watch List”

is an intermediate step towards either resolving the problem or terminating the manager. Managers

may only be removed from the “Watch List” under these two conditions.

A. Performance Criteria (liquid mandates)

A manager having performance that fails to meet certain performance criteria would

become eligible to be placed on the “Watch List”. First, any manager, regardless of tenure,

would be subject to Watch status if that manager’s investment performance falls through

the Short-term Relative to Benchmark criteria. Second, for managers with greater than

three years of performance history, a manager would be subject to Watch status if it fails

to achieve at least one Relative to Benchmark criteria (Medium-term or Long-term).

Specific criteria are located in the Appendix of each strategic program section.


SECTION C PAGE | 7

B. Performance Criteria (illiquid mandates)

Illiquid mandates are subject to different/customized criteria, which are discussed in the

applicable sections of this Manual.

C. Procedures

Once formally placed on the “Watch List” by the Board, the manager would be allowed a

reasonable amount of time to correct its performance (typically 9 to 15 months, if not

sooner). During this time, the Trustees may: i) instruct the manager to present in writing

and/or before the Board reasons for the underperformance, and/or ii) have the investment

consultant provide the Board with documentation that discusses the factors contributing to

the manager’s underperformance.

If a manager is placed on the “Watch List”, four actions are then generally available to the

Board:

1) To release a manager from the “Watch List”.

2) To extend “Watch List” status in order to determine whether any changes are

improving performance.

3) To reduce the managers assets by up to 100%.

4) To terminate the manager if performance continues to be below expectations.

Any of these actions would be supported by additional documentation (produced by the

applicable investment consultant and/or Investment Staff) that highlight the original

reasons for placing the manager on probation and discuss how these issues have or have

not been addressed. Underperformance would be evaluated in light of the manager's stated

style and discipline.

If the Trustees determine (with advice from the consultant) the manager is unlikely to meet

the above performance criteria and/or one of the qualitative indicators is violated without

signs of improvement, the manager may be terminated. A minimum of three years of

performance is preferred, but not required prior to termination.


SECTION C PAGE | 8

D. Watch List Guidelines - Qualitative Factors

Below are some of the qualitative factors that may be considered in determining whether

an investment manager should be placed on the “Watch List” or terminated.

FACTOR

EVALUATION TECHNIQUES

(VARIOUS TECHNIQUES

MAY BE USED, DEPENDING

ON NATURE OF VIOLATION)

ACTION STEPS

Violation of investment guidelines

and/or the laws of the State of

Hawai‘i

Review portfolio holdings vis-à-vis

the investment guidelines

Individual securities

their percentage weight in the

portfolio

Correct violation.

Review violations with manager to

reestablish compliance with

appropriate guidelines.

Manager to compensate ERS for

any losses that occurred from

violation.

Terminate or place on watch list -

terminate on additional violation.

Deviation from stated investment

style and philosophy

Style mapping- total fund analysis.

Style attribution - manager specific

style analysis.

Place on watch list. Monitor for

on-going fit with strategic

allocation policy. Terminate if no

longer consistent with strategic

allocation structure.

Changes in ownership Require immediate notification of

any pending changes in ownership

Place on watch list. Qualitatively

determine if change may

detrimentally affect asset

performance. If so, terminate.

Turnover of key personnel Require manager to establish a list

of key personnel, and rank in level

of importance, at the inception of the

account. Manager updates on an as

needed basis.

Place on watch list. Consider

termination if there is key

personnel turnover on the account

(as specified in the manager

provided list) or staffing is deemed

insufficient to appropriately

manage the ERS account.

Litigation Require manager to notify ERS Staff

immediately if entity which manages

the funds is involved in any

litigation

Evaluate nature, seriousness and

likely impact of charges on the

investment process and take

appropriate action.

Failure to disclose significant

information which could impact

manager evaluation

Require manager to provide

immediate full disclosure, in writing,

within a reasonable amount of time.

Review non-disclosure to

determine if material to manager’s

ability to manage assets. If so,

terminate.

Failure to disclose potential conflict

of interest in managing assets

Require manager to provide

immediate full disclosure, in writing,

within a reasonable amount of time

Review non-disclosure to

determine if conflict was material

and should have been known by

manager. If so, terminate.


SECTION C PAGE | 9

E. Watch List Guidelines - Quantitative Factors

Each strategic program section contains detailed information for individual investment

managers and their quantitative thresholds to be placed on the “Watch List”. These criteria

are customized for each manager/mandate based on their respective tracking error

expectations. The criteria are located in the Appendix of each strategic program section.

C.5. Investment Meeting Policy

A. Investment Managers

(1) Board Meetings: Investment managers shall present a formal investment portfolio

review to the Investment Committee and/or Board of Trustees once every three

years. At this presentation, investment managers should be represented by one or

more senior ranking members of the portfolio management team (e.g., portfolio

manager, chief investment officer).

(2) Staff Meeting: Investment managers shall present a routine investment portfolio

review to Investment Staff annually. The presentation should be held at the ERS

offices; however, the CIO may authorize an alternative communication means for

conducting the presentation, such as teleconferencing.

(3) Meeting Exceptions: The monitoring procedure may vary for private market

funds/managers, such as private equity and real estate. ERS’s private markets

consultants meet with private market managers on a regular basis

At either presentation, the investment manager will be expected to present appropriate

information about the firm and the portfolio, including, but not limited to, performance and

holdings, investment philosophy and process, organizational and personnel changes, new

and lost clients, and compliance issues related to this Manual and/or its investment

management agreement with the ERS.

Investment managers may be required to make a presentation to the Investment Committee

and/or Board of Trustees on a more frequent basis as stated in their contract or upon

request.

B. Consultants and Custodian

Investment Consultants and ERS bank custodians (“Custodian” or “custodian”) shall make

presentations to the Investment Committee and/or Board of Trustees at their regularly

scheduled meetings according to the contract or upon request.

At the discretion of the Investment Committee and/or Board of Trustees, such meetings

with Investment Consultants and Custodians may be conducted via an alternative

communication means such as teleconferencing.

C. Due Diligence Meetings

(1) Routine Due Diligence: Investment Staff shall conduct routine on-site, due

diligence meetings once every two years with each investment manager,

consultant, and custodian.


SECTION C PAGE | 10

(2) Watch List Status Due Diligence: Investment Staff shall conduct an on-site, due

diligence meeting of any investment manager or investment-related vendor that is

placed on the Watch List or other Board-approved probationary status. The on-site

visit will occur within a reasonable period but not later than one year from the date

when the investment-related vendor was placed on the Watch List or probation.

Investment Staff, in consultation with the general investment consultant, may

determine that an on-site due diligence meeting is unwarranted or that such due

diligence meeting be conducted at another point in time beyond the first year of

Watch List status.

(3) Vendor Search Due Diligence: Prior to executing a contract, Investment Staff shall

conduct an on-site, due diligence meeting when conducting an investment manager

or investment-related vendor search for all managers or vendors who appear on the

finalist list; or as appropriate, the on-site, due diligence meeting may be conducted

with the selected manager or vendor only. The results and findings of the on-site,

due diligence meeting should be conducted prior to any hiring decision unless

Investment Staff, in consultation with the general investment consultant,

determines that an on-site due diligence meeting is unwarranted.

The CIO may delegate the due diligence meeting responsibility to the general investment

consultant, or conduct the onsite due diligence jointly.

D. Industry Conferences or Educational Forums

Investment Staff and Trustees shall attend industry conferences and educational forums

that are essential and critical to discharging the responsibilities associated with institutional

investing. Section B.5 of this Manual addresses this policy provision: “It will be necessary

for the Trustees (and Staff) to travel to industry conferences and participate in educational

forums as opportunities arise.”

E. Staff Responsibilities

The Investment Office will maintain an Investment Meeting Calendar in order to plan

Trustee and Investment Staff investment meetings as outlined in this Manual.


SECTION C PAGE | 11

C.6. Reporting Requirements for Investment Managers

Investment Managers of Liquid Mandates

Monthly Reporting Requirements

A. Within five business days of the occurrence of any of the following, submit a written

explanation of the circumstances that resulted in:

(1) Transactions that result in the Custodian charging the ERS overdraft charges.

(2) Transactions that are extraordinary and warrant disclosure to the ERS (also include

items not reflected in the financial statements, e.g. significant changes in forward

contracts, etc.).

B. Reconciliation of Manager’s Monthly Report with Custodian’s Monthly Report

(1) To assist the Custodian with the reconciliation of asset position for both the number

of shares/par value and book value, income realized and gain/loss, and pricing, (in

U.S. dollar and local currency for foreign managers), managers must provide the

required information in a reasonable format (e.g. diskette, direct transmission,

etc.). Contact the Custodian for file format and layout.

(2) Each investment manager must reconcile its records to the Custodian’s reports. A

copy of the manager’s reconciliation report must be received within 30 days of the

close of the reporting month.

C. Fees

(1) Investment Manager’s fees are based on the Custodian’s reports. Fees are paid

quarterly and after-the-fact. Invoices are sent to the ERS and processed for

payment from the investment manager’s portfolio.

(2) Failure to submit written explanations of charges (e.g. bank overdraft) listed in

B.1. and B.2. above, may result in fees being adjusted at the discretion of the ERS.

(3) Fees may be adjusted if the market value of the portfolio presented in Custodian’s

reports is subsequently revised for pricing errors or other adjustments.

(4) On an annual basis, the applicable investment consultant shall write to the

investment managers inquiring whether the ERS is receiving the lowest fee

structure (favored nation clause). The investment consultant will inform the ERS

of any instance where the ERS is not receiving the lowest fee and recommend a

course of action.


SECTION C PAGE | 12

Quarterly Performance Reporting Requirements

A. Reporting Requirements

All of the information listed below shall be included in quarterly performance reporting.

Performance results shall be placed at the beginning of the report.

(1) A Statement of Assets.

(2) Performance results for the quarter, calendar year to date, fiscal year to date, and

preceding 1-year, 3-year and 5-year periods.

(3) An analysis of the positive and negative aspects of the investment strategy during

the quarter and how it affected the investment results.

(4) An economic outlook and investment strategy for the next quarter and/or year.

(5) One report is to be sent to the Investment Office in electronic format.

B. Organizational Changes

Important changes in an investment manager’s organization, staff and investment strategy

should be reported within 5 business days of their occurrence. Investment managers must

also promptly report any involvement in litigation, claims, assessments, regulatory

investigations, etc.

C. Registration Statement

Investment managers must also send the ERS annually a copy of part II of their registration

statement (Form ADV) on file with the Securities and Exchange Commission.

D. Presentations to the Board of Trustees

Except as stated in Section C.5.A. of this Manual, the Board of Trustees does not require

investment managers to meet with the Board on a regular basis. However, the Board, at its

discretion, may invite managers to discuss appropriate matters pertaining to the ERS

account. Attendance by manager representatives at the Board’s Annual Manager’s

Conference is required.

Investment Managers of Illiquid Mandates

Investment managers of illiquid mandates must abide by the reporting requirements stated within

the corresponding strategic/sub-component sections of this Manual.


SECTION C PAGE | 13

C.7. Employees’ Retirement System Distribution of Brokerage Commission

A. Each investment manager is charged with the responsibility of seeking the best execution

and best price in the best interest of the ERS.

B. No trades of any investment manager shall be done through their own parent, subsidiary,

or otherwise related firm. Also, no trades should be done which benefits a manager unless

prior approval has been given by the ERS for such actions.

C. Annual reports prepared by the Investment Staff summarizing the directed brokerage

transactions will be submitted to the Board of Trustees.


SECTION C PAGE | 14

C.8. Securities Lending Guidelines

The policies and guidelines governing the securities lending program shall pertain to the Custodian, unless

such services are contracted otherwise. A separate contract, distinct from the custody relationship,

detailing the type of securities lending relationship and program is both mandatory and essential in the

treatment of securities lending as, foremost, an investment function with the associated risks and return

implications, and fiduciary responsibility.

On an annual basis, the Custodian shall provide a detailed report of the ERS’s securities lending activities.

This summary shall be the basis for verification that the Custodian is complying with these securities

lending guidelines. After reviewing the report provided by the Custodian, the General Investment

Consultant shall prepare a report summarizing the ERS’s securities lending activity and compliance with

the ERS’s policies.

A. Objective

The Custodian, as the ERS’s securities lending provider, receives cash or government

securities (defined below) as Collateral for loans of their securities to approved Borrowers.

On an ongoing basis, the securities lending provider identifies eligible Collateral and, in

the case of cash Collateral, the opportunity for a market rate of return consistent with

allowed investment latitude and thereby seek to generate positive program spreads.

The securities lending provider must exercise investment discretion consistent with the

overall objective of: preserving principal; providing a liquidity level consistent with market

conditions and the lending and trading activities of the ERS; and maintaining full

compliance with stated guidelines and statutory provisions. The securities lending provider

shall exercise prudence and expertise in managing the cash collateral reinvestment

function.

B. Program Guidelines

Maintenance of the integrity and operational functionality of the securities lending program

shall be pursued with utmost diligence. The securities lending provider shall have

documented policies and procedures in place detailing the following if not stipulated in the

securities lending contract for both domestic and international securities.

- Borrower Limits/Creditworthiness

- Acceptable Collateral

- Marking to Market

- Corporate Actions/Distributions

- Proxy Voting Limitations

- Recall of Loaned Securities

- Revenue Splits

- Valuation and Reporting of Loaned Securities and Cash Collateral Reinvestments

- Borrower Risk (Default)

- Cash Collateral Reinvestment Risk

- Operational Negligence

- Counterparty Indemnification

- Other relevant policies


SECTION C PAGE | 15

The securities lending provider shall at all times exercise prudence and due care and shall

comply at all times with Section 88-121.5, Hawai‘i Revised Statutes and all other

applicable laws, rules and regulations of federal, state, and local entities or agencies

having jurisdiction, including but not limited to banking and securities regulatory bodies,

taxation authorities and the US Department of Labor.

C. Collateral Management

The securities lending provider shall exercise prudence and reasonable care in discharging

its discretion in the investment management of cash and non-cash collateral, including

asset/liability (gap) management that is appropriate relative to the market environment or

conditions that the securities lending provider is operating in. Provided that the

management of collateral, specifically cash, imposes the greater risk, the securities lending

provider shall adhere to the overall investment objective of ERS. Policies regarding issuer,

credit, exposure and rating limits utilized in the securities lending program per investment

vehicle shall be under the full discretion of the provider, and appropriate and consistent

with the stated general guideline. Issues such as exposure guidelines, prohibited securities

for cash investment, duration strategies, and matched and mismatched book are both

strategic and tactical investment functions and shall be consistent with the above objective.

Initial Collateral levels will not be less than 102% of the Market Value of the Borrowed

Securities, or not less than 105% if the borrowed securities and the Collateral are

denominated in different currencies. Marking-to-market is performed every business day

subject to de minimis rules of change in value, and the Borrower is required to deliver

additional Collateral when necessary so that the total Collateral held by the securities

lending provider for all loans to the Borrower of all participating lenders will at least equal

the market value of all the borrowed securities of all participating lenders loaned to the

Borrower.

Listed below are the cash and non-cash Collateral guidelines specifying eligible

investments, credit quality standards, and diversification, maturity and liquidity

requirements. Except for Prior Purchased Assets1, all requirements listed in these

guidelines are effective at the time of purchase of any security or instrument as a cash

Collateral investment and at the time of receipt of any non-cash Collateral. Agent will make

use of market standard settlement methods for cash investments and non-cash collateral

including the use of a tri-party custodian as approved by Agent’s appropriate risk

committee. Settlement through a tri-party custodian may result in cash collateral being

held on deposit at the tri-party custodian.

Cash Collateral Guidelines

Investment Objectives

Cash Collateral of the Collateral Account is invested to seek the following

objectives:

(i) preservation of capital

1 There may be certain assets held as Collateral that complied with the requirements of a prior version of these guidelines then in effect at the

time of purchase of such assets, but that may not meet these latest guidelines (such assets termed “Prior Purchased Assets”). Such Prior Purchased Assets may continue to impact the overall securities lending portfolio accordingly. The securities lending provider may, at its sole discretion, hold such Prior Purchased Assets until maturity, or as otherwise determined by it.


SECTION C PAGE | 16

(ii) maintenance of liquidity, and

(iii) maximization of current income to the extent consistent with (i),

and (ii), above

by investing cash Collateral in accordance with the guidelines stated below.

Within quality, maturity, and market sector diversification guidelines, investments

are made in those securities Agent judges to offer the most attractive relative

yields.

Investment Guidelines

A separate cash Collateral account shall be maintained for each currency, subject

to the eligibility rules below. Cash Collateral shall be denominated in either U.S.

Dollars or Euro currency, and shall be invested in securities or instruments

managed under the following guidelines:

Eligible Investments:

1. Securities and Exchange Commission (SEC) Rule 2a-7 money market

mutual funds.

2. Securities issued or guaranteed as to principal and interest by the

Government of the United States or issued or guaranteed by agencies

or instrumentalities thereof.

3. High-grade commercial paper and commercial paper master notes,

whether or not registered under the Securities Act of 1933, as

amended, and promissory notes. Obligor shall have a short-term

rating not lower than “A-1, P-1 or F-1”, at time of purchase.

4. Corporate obligations, including the banking industry, which are

marketable and rated high-grade. At the time of purchase, either the

long-term rating shall not be lower than “AA-, Aa3”, or the equivalent

thereof, or the short-term rating shall not be lower than “A-1, P-1, or

F-1” if less than one year remaining until maturity. Obligations may

include fixed, floating and variable rate notes and bonds.

5. Asset backed securities, at the time of purchase, shall have either a

long-term rating of “AAA, Aaa” or the equivalent thereof, or a short-

term rating not lower than "A-1, P-1, or F-1" if less than one year

remaining until maturity. Mortgage backed securities are not

considered asset backed securities for purposes of this restriction.

Asset backed securities must be collateralized by credit cards, auto

receivables, equipment trusts or student loans.

6. Certificates of deposit and other bank deposit obligations of U.S.

banks or U.S. branches or subsidiaries of foreign banks. At the time of

purchase, the issuing bank must have either a short-term issuer debt

rating not lower than "A-1, P-1, or F-1" or a long-term issuer debt

rating not lower than "AA-, Aa3", or the equivalent thereof.

7. Bankers' acceptances issued by U.S. banks or issued in the U.S. by

branches or subsidiaries of foreign banks. At the time of purchase, the

issuing bank must have either a short-term issuer debt rating not lower

than "A-1, P-1, or F-1" or a long-term issuer debt rating not lower than

"AA-, Aa3", or the equivalent thereof.

8. Repurchase agreements with respect to the following types of

collateral and repo counterparties:


SECTION C PAGE | 17

a. U.S. government securities, agencies, sovereigns, supranationals,

commercial paper, municipal bonds, asset-backed securities,

mortgage-backed securities (only pass-throughs), corporate bonds

(investment grade and high yield), and equities

b. The credit worthiness of the repurchase agreement counterparties

shall be monitored by Agent’s internal risk committee.

9. Sovereign debt obligations (other than U.S. Government obligations).

At the time of purchase, either the long-term rating shall not be lower

than “AA-, Aa3” or the equivalent thereof, or the short-term rating

shall not be lower than “A-1, P-1, or F-1” if less than one year

remaining until maturity.

10. Interests or units in any short-term investment fund (including,

without limitation, such funds of The Northern Trust Company and

any of its affiliates) that invests in any or of the types of investments

approved above.

11. Capped floaters, provided that Agent shall notify Lender of the usage

of such securities and shall employ appropriate risk assessment and

manage expertise as specified by the Office of the Comptroller of the

Currency.

12. Constant Maturity Treasury (“CMT”) floaters, provided that Agent

shall notify Lender of the usage of such securities and shall employ

appropriate risk assessment and manage expertise as specified by the

Office of the Comptroller of the Currency.

Maturity/Liquidity

The “maturity” of a security or instrument (or “maturities” for more than

one security or instrument) shall be defined as follows:

1. The shorter of the date on which the principal amount is ultimately

required to be paid or the put date under a demand feature, or

2. Variable rate eligible U.S. Government and U.S. Agency

obligations shall have a maturity equal to the date of the next

readjustment of the interest rate, or

3. The maturity of a pooled investment fund shall be the number of

days required to liquidate an investment in the fund under normal

market conditions, or

4. Asset-backed securities shall have a maturity equal to such

security's weighted average life (i.e. the average time to receipt of

expected cash flows on the security).

A minimum of 60% of the cash portion of the Collateral Account shall

be invested in securities which have a maturity (as herein defined) of

97 days or less.

A minimum of 20% of the cash portion of the Collateral Account shall

be available each business day. This may be satisfied by maturities (as

herein defined), or demand features.


SECTION C PAGE | 18

The rate sensitivity or weighted average maturity, as measured to the

shorter of the remaining time until the interest rate reset (if applicable)

or maturity, of the cash portion of the Collateral Account will be limited

to 60 days.

The weighted average maturity, as measured to maturity (as herein

defined), of the cash portion of the Collateral Account shall not exceed

120 days.

The maturity of fixed rate investments may not exceed 13 months from

the date of purchase. The maturity of floating rate Eligible

Investments, including the maturity of variable rate eligible U.S.

Government and U.S. Agency securities (as measured to final maturity

date, not the next readjustment of interest rate), may not exceed 2 years.

Diversification

Subject to the following exceptions, a maximum of 5% of the cash

portion of the Collateral Account may be invested in securities or

instruments of any one issuer or obligor. Exceptions are as follows:

1. 100% of the cash portion of the Collateral Account may be invested

in obligations issued or guaranteed by the U.S. Government or its

agencies/instrumentalities


with any one counterparty in repurchase agreements collateralized

by U.S. Government or U.S. Government agency securities


with any one counterparty in repurchase agreements collateralized

by eligible securities other than U.S. Government or U.S.

Government agency securities.

4. Residual cash balances, which cannot be invested into the

marketplace, shall not be subject to diversification limits.

General Ratings Provisions:

The ratings above must be designated by at least two Nationally

Recognized Statistical Rating Organizations ("NRSROs"), or if only

rated by one NRSRO, then rated at the time of purchase in the minimum

rating category specified by that NRSRO, as above. For the avoidance

of doubt, if all three NRSROs rate the obligation, then the obligation is

eligible as long as two NRSRO ratings meet the minimum criteria. In

the event that the obligation is not rated, the issuer rating shall be

considered with respect to the class of comparable short-term

obligation or long-term obligation.

Prohibited Transactions and Securities

The following transactions and securities are not permitted as direct

investments of Cash Collateral:

1. Additional leverage, which shall mean that Lender may not further

lend Eligible Investments in the Collateral Account.


SECTION C PAGE | 19

2. Highly leveraged, structured notes

3. Range floaters, COFI floaters, Dual Index floaters inverse floaters

and leveraged floaters

Non-Cash Collateral Guidelines

Listed below are the non-cash Collateral investment guidelines for eligible Collateral.

Investment Guidelines

Non-cash eligible instruments may consist of the following:

Eligible Investments

1. Obligations issued or guaranteed by the U.S. Government or its

agencies or instrumentalities thereof

2. Obligations issued or guaranteed by OECD (Organization for

Economic Cooperation and Development) member states or their

local governments, agencies or authorities

3. Canadian Provincial Debt

4. Equity securities, which are part of U.S. and non-U.S. indices

(including, but not limited to U.S., U.K., EMU, Japan, Canadian

and Australian markets), as approved by Agent’s internal risk

committee from time to time; and

5. Such other Collateral as the parties may agree to in writing from

time to time.

Credit Quality

Eligible Instruments as named above may be accepted without limit.

Diversification

Eligible Instruments as named above may be accepted without limit.

Operation of the Collateral Account

Income

Income earned from the investment of cash Collateral, net of (i) expenses,

including but not limited to, transaction accounting and reporting expenses,

auditing fees, brokerage fees and other commissions, and any miscellaneous

expenses, (ii) any applicable withholding of tax, (iii) loan rebate fees paid or

accrued to the borrowers, and (iv) any adjustments to provide for regular

returns, together with loan fees for loans Collateralized by non-cash Collateral,

are distributed to Lender of the Collateral Account on a monthly basis.

On a monthly basis, a portion of the income earned by Lender on a loan on any

business day may be withheld by Agent and transferred to income earned on a

different loan for that Lender on any other business day if on that day one or

more rebates due or accrued to borrowers with respect to one or more loans

should exceed the income earned from the cash Collateral supporting those

loans. If, despite such transfers, during any month total rebates payable exceed

total revenues with respect to any loan or loans of Lender, the net shortfall shall

be charged against positive undistributed earnings from other loans of Lender


SECTION C PAGE | 20

to the extent thereof, and any remaining shortfall shall be allocated between the

Lender and the Agent in the same proportions as positive securities lending

revenues. Any amounts thereby payable by the Lender shall be the personal

obligation of Lender and shall be due and payable upon the Lender’s receipt of

Agent’s invoice for such amounts. Agent may withhold (and Lender is deemed

to grant to Agent a lien upon) future loan revenues, and any other property of

the Lender then or thereafter in the possession of Agent, to secure the payment

of such obligation. Notwithstanding the foregoing, however, all other

Collateral losses shall not be shared between the Lender and the Agent to any

extent but shall be allocated as provided in the Agreement or these guidelines.

Incidental expenses, (e.g., negative float due to payment advances) incurred in

the administration of the Collateral Account are recovered against incidental

receipts, (e.g., positive float from pending balances) similarly arising and any

remaining balance is added to the lending revenues for the benefit of Lender.

Net realized short-term capital gains or losses (if any) may be distributed (or

charged) from time to time.

Net Asset Value

Lender hereby directs Agent to maintain the cash portion of the Collateral

Account as a fund comprised of units having a constant net asset value of $1.00

per unit and to value the fund using the amortized cost method (acquisition cost

as adjusted for amortization of premium or accretion of discount) for that

purpose. Agent will not determine or monitor the fair market value of the

investments as a means of comparing the unit value with the market value of

its investments. Lender hereby represents and confirms on a continuing basis

throughout the term of this Agreement that such a method of valuation and

account maintenance is consistent with all laws, rules, regulations and

accounting procedures applicable to Lender.

The cash portion of the Collateral Account intends to maintain a constant net

asset value within minimum tolerances established by Agent’s senior

management. There is no guarantee, however, that the cash portion of the

Collateral Account will be able to attain that objective. The Collateral Account

is not registered under the Investment Company Act of 1940 as a money market

fund, is not subject to regulation by the Securities and Exchange Commission

and does not comply with federal regulations governing registered money

market mutual funds.

In no event shall Agent be personally liable to restore any loss within the

Collateral Account, unless the loss was directly caused by the negligence or

intentional misconduct of Agent.

Trading Policy

Although the Collateral Account will generally not engage in short -term

trading, the Agent may dispose of any portfolio security prior to its maturity if,

on the basis of a revised credit evaluation of the issuer or other considerations,

Agent believes such disposition is advisable. Subsequent to its purchase, a

portfolio security or issuer thereof may be assigned a lower rating or cease to

be rated. Such an event would not necessarily require the disposition of the


SECTION C PAGE | 21

security, if the continued holding of the security is determined to be in the best

interest of the Lender. In any event, Agent will notify Lender as soon as

reasonably practicable if any security is downgraded after initial purchase

below the minimum requirements set forth in these investment guidelines.


SECTION C PAGE | 22

C. 9. Strategic Allocation Rebalancing Guidelines

A. Rebalancing Assets within the Strategic Allocation

One essential component of a strategic allocation policy is the development and use of

rebalancing ranges for the target allocation. According to several studies, systematic

rebalancing should reduce portfolio volatility and increase a portfolio’s risk-adjusted

return. Using the ERS’s long-term strategic target allocation, the greatest enhancement

to investment performance (i.e., enhancing the annualized return while lowering the

risk) is achieved by the rebalancing range shown below.

B. Target Mix with Rebalancing Ranges

Interim Lower Limit Strategic Allocation Upper Limit






The Investment Staff will maintain the classes within their target ranges primarily by using

cash flows, although the actual allocations will be rebalanced whenever a class is outside

of its strategic target range. The Board of Trustees should review the targets and ranges

annually for reasonableness relative to significant economic and market changes, and

relative to changes in the ERS’s long-term goals and objectives.

If the Plan has positive cash flow (i.e., contributions exceeding disbursements), Investment

Staff has the discretion to rebalance by directing new moneys to the under allocated

strategic classes on a pro-rata basis. If the Plan has negative cash flow, Investment Staff

has the discretion to withdraw moneys to be disbursed from over allocated strategic classes.

In each case, the CIO shall keep the Board of Trustees apprised of current asset movements.

Managing strategic allocations in this manner should not incur any additional transaction

cost beyond what would have been normally incurred to liquidate or invest assets.

Because of the unique valuation characteristics of certain elements within Real Return

and Broad Growth, these strategic classes have more subjective rebalancing ranges

relative to their target allocations. Concerns of liquidity and the long-term horizon for

these investments suggest a more infrequent rebalancing schedule. Accordingly, other

more qualitative considerations (e.g., transaction costs, liquidity needs, investment time

horizons, etc.) regarding the timing of rebalancing certain elements within Real Return

and Broad Growth will be important to consider with the guidelines shown above.


SECTION C PAGE | 23

C. Rebalancing Investment Style/Mandate Allocations Within Strategic Classes

With concurrence from the applicable investment consultant, Investment Staff is

responsible for maintaining appropriate style and mandate weightings, consistent with

the respective strategic classes' risk profile(s). Investment Staff and/or the applicable

investment consultant shall regularly report style and mandate weightings, and their

deviations from policy, to the Board. Any adjustments that causes a material change to

a strategic class' risk profile requires Board approval.

D. Single Manager Portfolio and Firm Allocation Limits for Active Mandates

In order to minimize any potential risk associated with large concentrations of the ERS’s

portfolio assets being managed in a single manager portfolio or by a single firm, the

following limits have been put in place:

(1) No single equity manager portfolio shall represent more than 5% of the total ERS

portfolio and

(2) No single manager/firm, when all active mandates associated with that

manager/firm are aggregated, shall represent more than 10% of the total ERS

portfolio.

If any single manager portfolio or manager/firm’s active assets exceed these limitations,

Investment Staff and the applicable investment consultant shall provide the Board its

solution to reallocate funds from that portfolio or manager/firm within the portfolio to

reduce the concentration within a reasonable time period.

Exemptions:

Gateway Investment Advisers, the ERS’s covered calls manager, was granted a temporary

exemption from the single manager portfolio limit at the September 14, 2015 Board

meeting.


SECTION C PAGE | 24

C. 10. Portfolio Transition Guidelines

From time to time the ERS will have a need to restructure its portfolios as a result of manager performance

or strategic allocation changes. The Board of Trustees, acting on recommendations and suggestions of the

Investment Staff and investment consultants, will decide to undertake actions to allocate assets to maintain

optimal strategic class weightings and/or to individual managers. The decision process will proceed as

follows.

A. Asset Transition Decision Process

(1) A determination will be made about the importance of maintaining the ERS’s

strategic allocation throughout the restructuring. If maintaining the strategic

allocation is desired, this can be accomplished through the simultaneous purchase

and sale of assets, through the use of futures, or other means.

(2) The Executive Director and CIO, with advice from the appropriate investment

consultants will determine the optimal course of action for effecting the desired

transition of assets. Rebalancing processes may include the use of a transition

manager or the direct transfer of in-kind securities to the target manager, for

example. When determining the optimal process, Investment Staff will seek to

maintain exposure to the market at all times (i.e., minimize time in cash assets) and

furthermore to minimize transaction costs, including, without limitation,

commissions, market impact, and opportunity cost. Whatever method chosen,

Investment Staff will maintain records that show firms selected for the transition

of assets have the depth of experience and commitment of resources to the portfolio

restructuring business. Additionally, Investment Staff’s evaluation will include

pre-trade cost analysis for the transition project.

(3) Manager(s) that may be selected by the ERS to manage and implement the

portfolio restructuring, should provide the ERS a pre- and post-trading cost

analysis so the results of the restructuring can be evaluated and the ERS’s fiduciary

obligation to monitor best execution is satisfied.

B. Asset Transition Steps

Each transition of assets project will be conducted according to the following steps.

(1) Trustees decide to restructure the portfolio through strategic allocation

rebalancing, strategic class changes, fund manager rotation, or other reasons.

(2) The Executive Director and CIO, with input from the appropriate investment

consultants, determine the optimal method to achieve the desired portfolio target.

(3) Investment Staff may solicit bid proposals and/or pre-trade analysis from the

ERS’s transition manager (TM) pool and/or other relevant entities.

(4) Investment Staff evaluates bid proposals and pre-trade analyses and the CIO

recommends to the Executive Director for selection.

(5) Administration/Accounting staff inform the following parties.


SECTION C PAGE | 25

a. TM(s) or other Manager(s): selected Manager(s) is/are notified in appointment

letter; other managers are also informed of not being selected.

b. Legacy Manager(s): informed of transition, including where applicable

transition amount (dollars), date to cease trading, date of termination, and

selected manager(s) (may be in the form of a termination letter).

c. Target Manager(s): informed of transition, including where applicable

transition amount (dollars), date of transition, date when fiduciary

responsibilities begin.

d. Custodian: through letter of direction, is informed of transition, including

where applicable the name of the manager(s) and contact, the name of the

legacy manager and contact, the name of the target manager and contact;

account numbers also indicated.

(6) Investment Staff maintains coordination and communication throughout the

transition process with other ERS staff and outside parties.

(7) Investment Staff evaluates performance of manager(s) during the trade and post-

trade by means of various reports.

(8) CIO reports transition highlights to the Executive Director and the Trustees when

appropriate.


SECTION C PAGE | 26

C. 11. Securities Litigation Guidelines

Securities litigation has become increasingly prevalent among public pension plans. The ERS is cognizant

that securities litigation can be a distraction to the ERS Board of Trustees, and the ERS staff, and a tax on

the ERS’s limited resources. In addition, because of the diversity of the ERS’s investment portfolio, and

the ERS’s investment policy guidelines, it is likely that other institutional investors will have a larger

financial interest in the relief sought in securities class action lawsuits and would therefore be more

appropriate lead or co-lead plaintiffs than the ERS. As such, the ERS generally does not seek or accept

lead or co-lead plaintiff status in securities class action lawsuits, but works diligently with the Plan’s

custodian to ensure that the ERS collects all that it is entitled to as the result of any settlements or judgments

in such lawsuits.

Custodian

The ERS utilizes the services of its custodian to monitor securities class action lawsuits with respect to

investments held by the ERS and to manage the timely filing of proofs of claim in such lawsuits. In this

regard, the ERS has adopted the following process:

1. The custodian will have a team that is dedicated to monitoring class action lawsuits.

2. The team creates and manages a database of all class action lawsuits which is accessed by

ERS service teams.

3. The ERS service team downloads class action notices and uses a tracking system based on

CUSIP. The custodian has access to this information because it handles custody for all of

the assets of the ERS.

4. If it is determined that the ERS held a security during the defined class period – according

to the class action notice, the custodian will file a claim on behalf of the ERS as a member

of the class. (Standing Instructions)

5. The custodian will not file for the ERS to become a lead plaintiff unless specifically

instructed to do so.

6. The custodian will obtain a claim number and track the class action through to settlement.

7. In the event that a claim is rejected by the claims administrator, the custodian shall

promptly notify the appropriate investment manager(s), and together they will identify the

best course of action to remedy the reason(s) for rejection, if possible.

8. The custodian will prepare and provide the ERS with an Excel spreadsheet report listing

class action filings and settlements that the ERS is involved in.

Monitoring Counsel

The ERS recognizes that there are situations when it could benefit from active participation in a securities

class action lawsuit or by taking some other action in pursuit of a securities claim. The State Attorney

General is therefore authorized to retain up to four law firms to: monitor the ERS's portfolio; identify,

analyze and evaluate possible ERS securities claims; provide information as to new or pending securities

lawsuits and settlements; and provide advice and recommendations as to whether the ERS should seek

active participation in a securities class action lawsuit, opt-out of a securities class action lawsuit, file or

participate in a nonclass action lawsuit or claim, or take some other action regarding a possible ERS

securities claim. The law firm or firms retained for this purpose ("monitoring counsel") shall perform their

services free of charge. ERS shall participate in the selection of monitoring counsel.

ERS will provide monitoring counsel with direct access to the ERS’s custodian electronic transaction

database. Recommendations by monitoring counsel shall be evaluated by the State Attorney General, who

shall be the primary contact with monitoring counsel.


SECTION C PAGE | 27

Monitoring counsel shall report to the State Attorney General all claims or potential claims. Monitoring

counsel shall provide their recommendation as to the appropriate action by the ERS with respect to any

claims or potential claims with recoverable losses (as defined by prevailing law addressing recoverable

losses) of $5,000,000 or more. When evaluating a recommendation from monitoring counsel that the ERS

become actively involved in securities litigation, the Attorney General and the Executive Director may

consider the following factors:

1. The size of the claim and the likely degree of recovery versus the time and costs involved

in pursuing the matter actively.

2. Staffing constraints that might make it difficult to effectively pursue the case actively (i.e.,

as a lead plaintiff or through an independent lawsuit).

3. Legal analysis of the merits of the case.

4. The availability of assets from which to collect a significant recovery.

5. Any unique issues or defenses to which the ERS might be subject in the particular case.

6. The effectiveness and availability of potential witnesses.

7. Any information regarding the claim from the applicable Investment Managers including

their ability to respond to requested discovery.

8. The effectiveness of potential alternatives for recovering the value of the claim, such as

corporate governance actions or less costly methods of monitoring the litigation.

9. Whether the active involvement of the ERS could add value to the potential resolution or

management of the case.

10. Whether any other institutional investors are in the class, and whether they are likely to

become actively involved.

11. The duties, obligations and liabilities to which the ERS might be subject to in pursuing

the matter actively.

12. The availability of insurance and/or indemnity for obligations and liabilities the ERS

might be subject to in pursuing the matter actively.

The State Attorney General will consult the Executive Director regarding monitoring counsel's

recommendation that the ERS become actively involved in litigation to pursue recovery of a claim or

potential claim. If the Executive Director recommends that the ERS become actively involved in litigation

to pursue recovery of a claim or potential claim with recoverable losses of $5,000,000 or more, then the

Executive Director will present his/her recommendation of a proposed course of action to the Board of

Trustees for approval. If the Executive Director determines that it would be in the best interest of the ERS

to become actively involved in litigation to pursue recovery of a claim or potential claim with recoverable

losses of less than $5,000,000, then the Executive Director is authorized to take reasonable steps necessary

to effectuate the ERS’s active involvement.

The ERS shall participate in the selection of counsel to represent the ERS in any litigation instituted to

pursue recovery of a claim or potential claim.


SECTION C PAGE | 28

C. 12. Responsible Investing

The ERS strives to integrate and consider Responsible Investing practices in overseeing the System’s assets.

This practice aims for a balance between the System’s financial goals and needs and the investment’s impact

on society by the actions of the corporation or entity in which the investment is made.

Falling within the realm of Responsible Investing is the consideration of environmental, social, and

corporate governance (ESG) factors, where ESG describes the three main areas of concern that have

developed as the central factors in measuring the sustainability and ethical impact of an investment in a

company or business. Within these three areas are a broad set of concerns that are increasingly being

included in the nonfinancial factors that figure in the valuation of equity, real estate, corporations,

infrastructure, and fixed income investments. Examples include but are not limited to, a company’s carbon

footprint, human rights, employee gender and ethnic diversity and non-discrimination, climate change, and

effective board oversight. ESG factors have the potential to affect the economic value and performance of

an investment now and in the future. Sound corporate governance policies and practices play an important

role in protecting economic value while enhancing value for long-term plan participants and beneficiaries.

The ERS strives to incorporate ESG into its investment process to identify and select investment partners

that share in its alignment of utilizing ESG factors when evaluating the value and risk of portfolio

companies.

Upon the encouragement by the House of Representatives of the Twenty-sixth Legislature of the State of

Hawai‘i, Regular Session of 2012, the ERS will continue to apply the principles of Responsible Investing

in investment practices and decisions where possible, and encourages other investment counselors and

money managers to apply Responsible Investing to their investment portfolios. The ERS believes that these

considerations align with its goal to provide strong long-term investment results to the System.

The following sections outline the ERS’s policies and efforts that pertain and support the practice of

Responsible Investing:

A. Proxy Voting

B. The Global Sullivan Principle

C. Anti-Terrorism Policies

D. Sudan Policies

E. United Nations – Supported Principles for Responsible Investment (PRI)

F. HiTIP Policies and Procedures (Created by the ERS to fulfill the mandate of Act 260, “A Bill

For An Act Relating To The Innovation Economy.”)

http://en.wikipedia.org/wiki/Sustainability

http://en.wikipedia.org/wiki/Investment

http://en.wikipedia.org/wiki/Equity_(finance)

http://en.wikipedia.org/wiki/Real-estate

http://en.wikipedia.org/wiki/Corporations


SECTION C PAGE | 29

A. Proxy Voting

The ERS has a fiduciary responsibility to act solely in the best interest of its members and

beneficiaries and the right to vote proxies is considered by the ERS as an important part of

its fiduciary duty. The ERS will use its rights as an active shareholder to manage risks and

hold companies in which they invest accountable for the business decisions the company

makes.

The ERS has established comprehensive proxy voting and reporting guidelines that can be

customized as necessary to further align the policy with the System’s specific interests.

As a starting point, the ERS elected to utilize the Public Pension Policy established by

Glass, Lewis & Co.to guide proxy voting decisions. The Public Pension guidelines are

designed to ensure compliance with the special fiduciary responsibilities of public pension

plan sponsors in voting proxies on behalf of public employees. The guidelines are designed

for investors with extremely long-term investment horizons. While the recommendations

reflect analysis and identification of both financial and corporate governance risk, the

guidelines also include consideration of stakeholder interests in making proxy voting

decisions. The guidelines encourage increased reporting and disclosure on the part of

portfolio companies including executive compensation, governance, labor practices and

the environment. Glass Lewis evaluates the Public Pension guidelines on an ongoing basis

and formally updates them on an annual basis if needed. Additionally, the ERS can further

adjust the voting policy to reflect the System’s specific ESG preferences and beliefs.

The ERS shall retain a proxy voting administrator to aggregate, research, and vote the

ERS’s proxies related to the Plan’s applicable public markets separate accounts. The proxy

voting administrator shall have delegated authority to vote the ERS’s proxies according to

guidelines selected/customized by the ERS. On an ongoing basis the proxy voting

administrator shall review the ERS’s proxy voting guidelines and annually, or more

frequently if necessary, update the guidelines if needed. The proxy voting guidelines are

designed to ensure compliance with the fiduciary responsibilities of public plan sponsors

voting proxies on behalf of the Plan’s participants. The proxy voting administrator shall

report to the ERS the proxies voted on behalf of the Plan at least annually, or more

frequently upon request.

The ERS reserves the right to delegate proxy voting authority to any managers not able to

adhere to the proxy guidelines selected by the ERS, where proxy voting authority cannot

be delegated to the Plan’s proxy voting administrator (i.e. public equity commingled

funds), or where the manager votes proxies only on rare occurrence (i.e. fixed income

mandates). Any investment manager voting proxies on behalf of the Board will do so with

the primary objective of maintaining and advancing the economic value and interests of

ERS members. ERS also requests these investment managers, as part of their investment

discretion and fiduciary responsibility, to take into consideration the importance of the

Corporate Governance Policies promulgated by the Council of Institutional Investors,

proxy voting guidance available through the CFA Institute, and the Global Sullivan

Principles. Investment Staff, with the assistance of the applicable investment consultants,

shall poll these managers annually as to their proxy voting policies. A letter affirming

compliance with the manager’s proxy voting guidelines will be requested from these

applicable managers on an annual basis. The ERS may request from each manager reports

of the proxy votes cast on the ERS’s behalf for review.


SECTION C PAGE | 30

Corporate Governance Policies

Council of Institutional Investors

(reprinted from www.cii.org)

The ERS believes in carrying forward the Council of Institutional Investors’ (CII) goal of

instituting strong governance standards at public companies and strong shareholder rights.

CII believes effective corporate governance and disclosure serve the best long-term

interests of companies, shareholders and other stakeholders. CII supports shareholders’

discretion to employ a variety of stewardship tools to improve corporate governance and

disclosure at the companies they own, which includes casting well-informed proxy votes.

The ERS encourages its investment managers and proxy voting provider to use the

Corporate Governance Policies established by the CII to guide proxy voting decisions

when casting votes on behalf of the ERS.

The Council expects that corporations will comply with all applicable federal and state

laws and regulations and stock exchange listing standards.

The Council believes every company should also have written disclosed governance

procedures and policies, an ethics code that applies to all employees and directors, and

provisions for its strict enforcement. The Council posts its corporate governance policies

on its web site (www.cii.org); it hopes corporate boards will meet or exceed these standards

and adopt similarly appropriate additional policies to best protect shareholders’ interests.

In general, the Council believes that corporate governance structures and practices should

protect and enhance accountability to, and ensure equal financial treatment of,

shareholders. An action should not be taken if its purpose is to reduce accountability to

shareholders.

The Council also believes shareholders should have meaningful ability to participate in the

major fundamental decisions that affect corporate viability, and meaningful opportunities

to suggest or nominate director candidates and to suggest processes and criteria for director

selection and evaluation.

The Council believes companies should adhere to responsible business practices and

practice good corporate citizenship. Promotion, adoption and effective implementation of

guidelines for the responsible conduct of business and business relationships are consistent

with the fiduciary responsibility of protecting long-term investment interests.

The Council believes good governance practices should be followed by publicly traded

companies, private companies and companies in the process of going public. As such, the

Council believes that, consistent with their fiduciary obligations to their limited partners,

the general members of venture capital, buyout and other private equity funds should use

appropriate efforts to encourage companies in which they invest to adopt long-term

corporate governance provisions that are consistent with the Council’s policies.

The Council believes that U.S. companies should not reincorporate offshore because

corporate governance structures there are weaker and therefore reduce management

accountability to shareholders.

Council policies neither bind members nor corporations. They are designed to provide

guidelines that the Council has found to be appropriate in most situations.


SECTION C PAGE | 31

Proxy Voting Guidance for ERS Investment Managers with Delegated Proxy

Authority

To meet their fiduciary duty with regard to corporate governance, investment managers

must follow adequate procedures concerning the voting of proxies. When ERS managers

are given the responsibility to vote proxies, they must adopt procedures to ensure that issues

are noted, analyzed, and considered before voting. Investment managers must be

thoroughly familiar with the issues that arise in proxies. Proxies have economic value and

must be voted in the interest of the ultimate shareholder or plan beneficiary. Investment

managers cannot simply vote without adequate examination of the underlying issues.

Managers of this type may refer to the CFA Institute for general proxy voting guidance.

The skills and experience of the professional investment community, particularly the

research and analytic skills, can be used effectively in corporate governance issues, which

will ultimately benefit corporations and shareholders alike and enhance the

competitiveness of business in global markets. Good corporate governance and good

investment decisions go hand in hand.

B. The Global Sullivan Principles

(1) Preamble

The objectives of the Global Sullivan Principles are to support economic, social

and political justice by companies where they do business; to support human rights

and to encourage equal opportunity at all levels of employment, including racial

and gender diversity on decision making committees and boards; to train and

advance disadvantaged workers for technical, supervisory and management

opportunities; and to assist with greater tolerance and understanding among

peoples; thereby, helping to improve the quality of life for communities, workers

and children with dignity and equality. I urge companies large and small in every

part of the world to support and follow the Global Sullivan Principles of corporate

social responsibility wherever they have operations.

Feb. 1, 1999

The Rev. Leon H. Sullivan

(2) Principles

As a company which endorses the Global Sullivan Principles we will respect the

law, and as a responsible member of society we will apply these Principles with

integrity consistent with the legitimate role of business. We will develop and

implement company policies, procedures, training and internal reporting structures

to ensure commitment to these principles throughout our organization. We believe

the application of these Principles will achieve greater tolerance and better

understanding among peoples, and advance the culture of peace.

Accordingly, we will:

(1) Express our support for universal human rights and, particularly, those of our

employees, the communities within which we operate, and parties with whom we

do business.


SECTION C PAGE | 32

(2) Promote equal opportunity for our employees at all levels of the company with

respect to issues such as color, race, gender, age, ethnicity or religious beliefs, and

operate without unacceptable worker treatment such as the exploitation of children,

physical punishment, female abuse, involuntary servitude, or other forms of abuse.

(3) Respect our employees’ voluntary freedom of association.

(4) Compensate our employees to enable them to meet at least their basic needs and

provide the opportunity to improve their skill and capability in order to raise their

social and economic opportunities.

(5) Provide a safe and healthy workplace; protect human health and the environment;

and promote sustainable development.

(6) Promote fair competition including respect for intellectual and other property

rights, and not offer, pay or accept bribes.

(7) Work with governments and communities in which we do business to improve the

quality of life in those communities – their educational, cultural, economic and

social well-being – and seek to provide training and opportunities for workers from

disadvantaged backgrounds.

(8) Promote the application of these principles by those with whom we do business.

We will be transparent in our implementation of these principles and provide information

which demonstrates publicly our commitment to them.

5/26/99

Source of Global Sullivan Principles: mallenbaker.net,

http://www.mallenbaker.net/csr/CSRfiles/gsprinciples.html, 11/05/03

ERS has a fiduciary responsibility to act solely in the interest of its members and

beneficiaries. Therefore investment managers voting proxies for the board will do so with

the primary goal of maintaining or increasing the economic interests of ERS.

C. Anti-Terrorism Policy

(1) Introduction

Since 9/11, attention has been focused on the potential security threats certain

countries and specific companies pose to the United States of America. The ERS

Board of Trustees recognize the heightened awareness of security risks and the fact

that public pension funds have come under increased pressure from the general

public to divest from companies that do business in countries that support

terrorism. On the surface this issue may appear simple and straightforward, but in

reality it is very complex and requires information that is not currently available to

public pension funds. A policy as simple as requiring divestiture from all

companies that do business in certain countries may actually work to the detriment

of US foreign policy objectives and needlessly damage US companies and jobs.

The Board maintains its fiduciary obligations to the members of the System as its

top priority. This requires the Board to act prudently and in the exclusive interest

of participants in the management of System assets. In an effort to balance their


SECTION C PAGE | 33

fiduciary obligations with their moral and ethical responsibility as citizens of the

United States of America, the Board of Trustees is hereby establishing this Anti-

Terrorism Investment Policy.

(2) Background on US Foreign Policy Related to Countries Supporting Terrorism

In the area of foreign policy, regulations and sanctions are complex and continually

changing to address the needs of US national security. The US State Department

maintains an official list of countries that the US deems to be supporting

international terrorism. The countries included on this list and the regulations and

sanctions that apply in these countries change frequently. Unfortunately, a list of

companies that are deemed to be supporting terrorism is not publicly available at

this time. The fact that a company may have a business link to a listed country

does not mean that the US government believes the company is supporting

terrorism. In many cases, the US government allows business relationships

because they believe they further US policy goals via the contracts and leverage

that trade and other business connections create. Placing investment restrictions

that would discourage business relationships in these countries could actually run

counter to US anti-terrorism initiatives in some instances. As a result of the

complexities and lack of public information in this area, ERS must rely upon

federal agencies such as the Securities and Exchange Commission and the State,

Commerce, Justice and Treasury Departments to provide factual information

regarding companies that are supporting terrorism. To date, this information has

not been available to ERS or any other public pension fund. Quite simply, factual

information that ERS would need to prudently divest from these companies is not

available.

(3) ERS’s Actions Related to an Anti-Terrorism Policy

Given the importance of this issue, on an annual basis, the Chief Investment

Officer will contact the Department of Homeland Security, the State Department,

the Commerce Department, the Justice Department, the Treasury Department, the

Securities and Exchange Commission, and any other federal agency deemed to

have useful information in accurately identifying companies that are supporting

terrorism. Specifically, the CIO will request guidance from these agencies on

countries and more specifically companies that are believed to be supporting

terrorism. Once the information is received, Investment Staff will compare the list

of companies with current holdings. In the event that ERS is a holder of one of

these companies, the CIO will immediately contact the manager of the specific

investment account to bring the situation to their attention and discuss appropriate

actions for divesting from the company. In addition, the CIO will forward all

information received from any of these federal government agencies to our

investment managers so they can avoid making initial investments or divest of

existing investments in companies that are identified as supporting terrorist

activities. Finally, the CIO will provide a report to the Board on an annual basis

that identifies any investment actions taken due to links to terrorist activities.

This policy is intended to avoid 1) discriminating against companies whose

activities abroad are supported by the US government; 2) discriminating against

companies whose activities abroad do not further terrorism; 3) unnecessarily

harming US companies and jobs; and 4) compromising the Board’s fiduciary

duties to the beneficiaries of the System. Recognizing the dynamic nature of the


SECTION C PAGE | 34

issue, annually Investment Staff will evaluate this policy to determine if changes

need to be made to reflect recent developments in this area. In the event that

Investment Staff believes changes to this policy are warranted, they will bring the

issue to the attention of the Board of Trustees for consideration.

D. Sudan Investment Policy

Act 192, Session Laws of Hawai‘i 2007, expresses the State’s desire to not participate in

ownership of companies that provide “significant practical support” for genocide activities

as currently being conducted by the Sudanese government in the Darfur region. The ERS

Board of Trustees wishes to recognize its agreement with the intent of Act 192 and to abide

by its requirements. The Board, however, also applies a decision framework of acting for

the exclusive benefit of ERS Plan participants. In this respect, the Board recognizes that

divestment activities could potentially increase the portfolio’s idiosyncratic investment

risk. Therefore, divestment guidelines and procedures should seek to minimize the impact

of a specific divestment policy (such as Sudan divestment) upon the investment results of

the portfolio.

The Board has determined to use the following procedures to comply with Act 192 by

requiring the CIO, or another designated member of Investment Staff, to:

(1) Assemble a list of all direct holdings in “scrutinized companies”2;

(2) Review publicly available information regarding companies with business

operations in the Sudan provided by nonprofit organizations (e.g., the Sudan

Divestment Taskforce) and other appropriate parties;

(3) Send written notice informing companies of their scrutinized company status and

the possibility that they may become subject to divestment;

(4) Monitor other institutional investors that have divested from or engaged with

companies that have business operations in Sudan;

(5) Consider divestment or other corrective actions to the extent reasonable with due

consideration for among other things, return on investment, diversification, and the

System’s other legal obligations;

(6) Inform the ERS's equity investment managers of Board decisions as related to the

above processes; and

(7) Review and update progress of scrutinized companies on a quarterly basis.

This policy is intended to avoid: 1) discriminating against companies whose Sudan-related

business activities are supported by the U.S. government; 2) discriminating against

companies whose Sudan-related business activities do not support genocide activities; 3)

unnecessarily harming U.S. companies and jobs; and 4) compromising the Board’s duties

to the beneficiaries of the ERS.

2 Reference Act 192, Section 2. Definitions of “Scrutinized Company.”


SECTION C PAGE | 35

E. United Nations – Supported Principles for Responsible Investment (“PRI”)

In May 2018, the ERS became a signatory of the United Nations – Supported Principles

for Responsible Investment. The six Principles for Responsible Investment are a voluntary

and aspirational set of investment principles that offer a selection of possible actions for

incorporating environmental, social, and corporate governance issues into investment

practice. The signatories’ commitment is as follows:

“As institutional investors, we have a duty to act in the best long-term interests of our

beneficiaries. In this fiduciary role, we believe that environmental, social, and corporate

governance (ESG) issues can affect the performance of investment portfolios (to varying

degrees across companies, sectors, regions, asset classes and through time).

We also recognize that applying these Principles may better align investors with broader

objectives of society. Therefore, where consistent with our fiduciary responsibilities, we

commit to the following:

Principle 1: We will incorporate ESG issues into investment analysis and decision-

making processes.

Principle 2: We will be active owners and incorporate ESG issues into our

ownership policies and practices

Principle 3: We will seek appropriate disclosure on ESG issues by the entities in

which we invest.

Principle 4: We will promote acceptance and implementation of the Principles

within the investment industry.

Principle 5: We will work together to enhance our effectiveness in implementing

the Principles.

Principle 6: We will each report on our activities and progress towards

implementing the Principles.

The Principles for Responsible Investment were developed by an international group of

institutional investors reflecting the increasing relevance of environmental, social and

corporate governance issues to investment practices. The process was convened by the

United National Secretary-General.

In signing the Principles, we as investors publicly commit to adopt and implement them,

where consistent with our fiduciary responsibilities. We also commit to evaluate the

effectiveness and improve the content of the Principles over time. We believe this will

improve our ability to meet commitments to beneficiaries as well as better align our

investment activities with the broader interests of society.

We encourage other investors to adopt the Principles.”

Source: https://unpri.org

As part of its commitment to the PRI, the ERS shall report on an annual basis its progress

in implementing the PRI’s Six Principles.

https://unpri.org/


SECTION C PAGE | 36

F. Hawaiian Targeted Investment Program (Hi-TIP)

HiTIP was initiated to fulfill the mandate of Act 260, “A Bill For An Act Relating To The

Innovation Economy” passed by the Legislature and signed by the Governor in July 2007.

The stated purpose of Act 260 is “to encourage the employees’ retirement system to invest

in Hawai‘i venture capital…”

The legislation pertains to HiTIP in that HiTIP targets investments that are directly a part

of the Hawaiian community.

A full account of the Hawaiian Targeted Investment Program can be found in Section H

Hawai‘i Targeted Investment Program Policies and Procedures.


SECTION C PAGE | 37

C.13. Policy for the Use of Placement Agents

The ERS shall require the specific and timely disclosure of payments and compensation to Placement

Agents3 in connection with the ERS’s investments. This Placement Agent Policy is intended to apply

broadly to all investment contracts made by the ERS. The goal of this Placement Agent Policy is to help

ensure that the ERS investment decisions are made by the Board solely on the merits of the investment

opportunity in accordance with the Board of Trustees’ fiduciary responsibility and to avoid the appearance

of undue influence on the Board or illegal pay-to-play practices in the award of investment related contracts.

A. Investment Manager Placement Agent Disclosures

Each investment manager shall provide to the ERS the required information listed below

within 45 days of the initiation of investment discussions between the investment manager

and the ERS but in any event prior to the completion of due diligence. The investment

manager must notify the Investment Staff of any changes to any of the information required

within 14 calendar days of the investment manager knowing of the change(s).

(1) Required Disclosure of Payments Made to Placement Agents

a. A written statement of whether the investment manager or any of its

principals, employees, agents or affiliates has compensated or agreed to

compensate any person or entity to act as a Placement Agent in connection

with the ERS’s investments.

b. The name of the Placement Agent, and resumes of every officer, partner

and principal of the Placement Agent. The resumes shall include

educational history, professional designations, regulatory licenses and

investment and work experience.

c. Description of any and all compensation paid or agreed to be paid to the

Placement Agent, including payment to employees of the investment

manager who are retained in order to solicit, or who are paid based in

whole or in part upon, an investment from the ERS.

d. Description of the services rendered or the services expected to be

performed by the Placement Agent and a list of the prospective clients for

which such Placement Agent is utilized.

e. Copies of all agreements between the investment manager and the

Placement Agent.

f. Name of the regulatory agencies the Placement Agent or any of its

affiliates are registered with, such as The Securities and Exchange

Commission (SEC), the Financial Industry Regulatory Association

(FINRA), or any similar regulatory agency; proof and details of such

registration shall be included, or an explanation as to why no registration

is required.

3 “Placement Agent” includes any person or entity hired, engaged, retained by, acting on behalf of or serving for the benefit of an investment

manager or on behalf of another Placement Agent as a third-party marketer, finder, solicitor, marketer, consultant, broker, or other intermediary to market, solicit, obtain access to the ERS, and/or raise money or investments either directly or indirectly from the ERS. Notwithstanding the

foregoing, an individual who is an employee, officer, director, equity holder, partner, member or trustee of an investment manager and who spends

one-third or more of his or her time, during a calendar year, managing the securities or assets owned, controlled, invested or held by the investment manager is not a Placement Agent.


SECTION C PAGE | 38

(2) Required Disclosure of Relationships to the Board and; Campaign Contributions

a. Full disclosure of any connection between the Placement Agent or the

investment manager and the ERS, including whether anyone receiving

compensation or who will receive compensation with respect to an

investment from the ERS from the Placement Agent or the fund manager

is: a current or former ERS Board Member, ERS employee, or ERS

consultant; a member of the immediate family of anyone connected to or

formerly connected to the ERS; a current or former elected or appointed

official of the State and/or cities and counties of the State, a current or

former employee of the State and/or cities and counties of the State; or

anyone seeking to be elected to public office of the State and/or cities and

counties of the State or a member of his/her campaign organization or a

political action committee.

b. Full disclosure of the donations made by the Placement Agent or the

investment manager during the prior 24-month period to any organization

(including contributions to political campaign funds and donations to non-

profits) in which any person listed in Paragraph 2.a is an officer, employee,

or member of the Board or Advisory Board (or similar body).

Additionally, any subsequent donations made by the Placement Agent or

the investment manager to any such organization during the time the

Placement Agent or the investment manager is receiving compensation in

connection with a the ERS investment shall also be disclosed.

c. Full disclosure of the names of any current or former members of the

Board, ERS employees or investment consultants who suggested the

retention of the Placement Agent to the investment manager.

B. Responsibilities of Staff and Consultants

At the time that investment discussions between an investment manager and the ERS for a

prospective investment commence, Investment Staff is responsible for providing

investment managers and Placement Agents with a copy of this Placement Agent Policy.

Investment Staff and investment consultants must confirm that the applicable Placement

Agent disclosures have been received prior to the completion of due diligence and

completion of any recommendation to proceed with the decision to invest with the

investment manager. For new contracts and amendments to existing contracts, the ERS

will:

Stop investment negotiations with an investment manager who refuses to disclose

the required information;

Decline the opportunity to retain or invest with an investment manager who has

used or intends to use a Placement Agent who is not registered with the SEC,

FINRA, or any similar regulatory agency and cannot provide an explanation as to

why no registration is required; and


SECTION C PAGE | 39

Investment Staff and investment consultants will assist legal counsel as necessary to secure

in the final contract terms and side letter agreements between the ERS and the investment

manager, including but not limited to, the following:

The investment manager’s agreement that it has complied with and will continue

to comply with this Placement Agent Policy.

The investment manager’s representation and warranty that it will notify the

Investment Staff of any changes to any of the information required above within

14 calendar days of when the investment manager knows or should have known of

the change(s).

At any meeting where an investment decision with an investment manager will be

considered, Investment Staff and the applicable investment consultants must notify the

Board of the name(s) of any Placement Agent(s) used by the investment manager in

connection with the proposed investment, and any campaign contributions or gifts reported

by each Placement Agent.

Staff must maintain records of all information disclosed to the ERS in accordance with this

policy, and provide the Board with notice of any violation of this policy as soon as

practicable.

C. Responsibilities of Counsel

Legal counsel to the ERS must secure in the final contract terms and side letter agreements

between the ERS and the investment manager all requisite agreements and representations

and warranties by the investment manager for compliance in accordance with this

Placement Agent Policy.

D. Responsibilities of the Board

The Board must review all violations of this Placement Agent Policy reported by

Investment Staff, consider whether each violation is material, and consider whether to

prohibit that investment manager and/or Placement Agent from soliciting new investments

from the ERS for a certain period (the length of such period to be at the Board’s sole

discretion) from the date of the determination.


SECTION C PAGE | 40

C.14. Board of Trustees Discretionary Account Guidelines

The ERS shall exercise prudence and reasonable care in discharging its discretion in the investment

management of assets held in the Board of Trustees (BOT) Discretionary account.

A. Investment Objectives

Assets held in the BOT Discretionary account shall be invested to seek the following

objectives:

(i) preservation of capital

(ii) maintenance of liquidity, and

(iii) maximization of current income to the extent consistent with (i), and (ii), above by

investing assets in accordance with the guidelines stated below.

B. Investment Guidelines

Funds shall be denominated in U.S. Dollars and shall be invested in securities or

instruments managed under the following guidelines:

Eligible Investments:

1. Securities and Exchange Commission (SEC) Rule 2a-7 money market mutual

funds of institutional grade4.

2. Interests or units in any short-term investment fund (including, without limitation,

such funds of BNY Mellon and any of its affiliates) that invests in any of the types

of investments approved above.

Liquidity

A minimum of 95% of the available cash portion of the BOT Discretionary account

shall be invested in Eligible Investments (1) and/or (2) above.

4 Rule 2a-7 of the act restricts the quality, maturity and diversity of investments by money market funds. Under this act, a money

fund mainly buys the highest rated debt, which matures in under 397 days. The portfolio must maintain a weighted average

maturity of 60 days or less and not invest more than 5% in any one issuer, except for government securities and repurchase

agreements

https://en.wikipedia.org/wiki/Debt

https://en.wikipedia.org/wiki/Maturity_(finance)

https://en.wikipedia.org/wiki/Maturity_(finance)

https://en.wikipedia.org/wiki/Government_bond

https://en.wikipedia.org/wiki/Repurchase_agreement

https://en.wikipedia.org/wiki/Repurchase_agreement


SECTION D

B R O A D G R O W T H P R O G R A M

S E C T I O N: D


SECTION D

TABLE OF CONTENTS

Page

1. OVERVIEW ........................................................................................................................................... 1

A. GENERAL DESCRIPTION ........................................................................................................... 1

B. PURPOSE ........................................................................................................................................ 1

C. RISK FACTOR EXPOSURES ....................................................................................................... 1

2. CLASS STRUCTURE ........................................................................................................................... 2

A. COMPONENTS .............................................................................................................................. 2

B. MODIFICATIONS TO COMPONENT STRUCTURE ................................................................ 3

C. COMPONENTS’ ALLOCATIONS AND ALLOCATION RANGES ......................................... 3

D. MANAGEMENT OF COMPONENTS ......................................................................................... 4

E. COMPONENTS’ MANAGERS & MANAGERS’ ALLOCATIONS .......................................... 5

3. RETURN OBJECTIVES & RISK PROFILE ....................................................................................... 7

A. CLASS RETURN BENCHMARKS .............................................................................................. 7

B. CLASS RISK PROFILE ................................................................................................................. 8

C. COMPONENT RISK PROFILES .................................................................................................. 8

4. MANAGER INVESTMENT GUIDELINES ...................................................................................... 10

A. TRADITIONAL GROWTH COMPONENT MANAGERS ....................................................... 10

B. STABILIZED GROWTH COMPONENT MANAGERS ........................................................... 13

APPENDIX

DERIVATIVES POLICY ............................................................................................................. 18

WATCH CRITERIA AND IMPLIED EXCESS RETURNS ...................................................... 19

CORE REAL ESTATE SUBCOMPONENT ............................................................................... 20

CREDIT SUBCOMPONENT ....................................................................................................... 37

PRIVATE GROWTH COMPONENT ......................................................................................... 43


SECTION D PAGE | 1

D.1. Overview

A. General Description

The Broad Growth class consists of investment strategies and assets that are largely

exposed and/or susceptible to changes in global economic growth and corporate

profitability. Such investments typically contain relatively high degrees of risk and exhibit

more volatility than other strategic classes. The Broad Growth class consists of three major

components: Traditional Growth, Stabilized Growth, and Private Growth. The Traditional

Growth component consists largely of global public equity and other similar-risk

investments. The Stabilized Growth component consists of a spectrum of growth-exposed

investment strategies that exhibit expected returns close to Traditional Growth

investments, but exhibit materially lower levels of volatility. The Private Growth

component consists of growth-oriented higher-risk investments that rely on the private

markets rather than the public markets to raise investment capital.

B. Purpose

The Broad Growth class provides the bulk of the total portfolio’s investment return due its

exposure to the equity risk premium. The equity risk premium, while volatile, is the reward

associated with bearing economic and corporate risk – it is the highest risk premium

available to investors. In addition, over long investment horizons (i.e., greater than 10

years), the equity risk premium is generally significantly positive after accounting for

inflation. Due to this feature, the Broad Growth class is expected to increase the purchasing

power of the total portfolio’s assets over time.

By diversifying into the three major Broad Growth components (Traditional Growth,

Stabilized Growth, and Private Growth), the Broad Growth class seeks to moderate its risk

profile versus investing solely in any one component. This approach seeks to capture the

entirety of the equity risk premium as well as capture premiums associated with other risk

factors that are closely related to the equity risk premium.

C. Risk Factor Exposures

Major

- Growth Risk

Minor

- Interest Rate Risk

- Liquidity Risk


SECTION D PAGE | 2

D.2. Class Structure

A. Components

The Broad Growth class consists of three major components: Traditional Growth,

Stabilized Growth, and Private Growth.

Traditional Growth

Component currently includes the entire publicly-traded (i.e., liquid) global equity

market opportunity set.

Other similar-risk public-market investment strategies considered for Traditional

Growth include:

- Equity-biased long/short

- Liquid opportunistic credit

Stabilized Growth

Component includes a spectrum of liquid and illiquid investment strategies that are

primarily exposed to economic risk (similar to investments within the Traditional

Growth component) with risk profiles that exhibit 25%-50% less volatility than

strategies within the Traditional Growth component. Strategies currently included in

this component are:

- Covered call writing

- Public market credit strategies (investment-grade debt, high yield debt)

- Cash-secured put-writing

- Defensive/low volatility public equity

- Core real estate

Other similar-risk investment strategies considered for Stabilized Growth include:

- Long/short equity and credit

- Dynamic derivative-based strategies

- Private market credit strategies

Private Growth

Component includes a spectrum of private markets investment strategies that are

primarily exposed to economic growth risk and can exhibit high levels of measured

investment risk. Private markets strategies currently included in this component are:

- Buyout equity

- Growth capital

- Venture capital

- Distressed debt

- Mezzanine debt

- Special situations

- Non core real estate


SECTION D PAGE | 3

More detailed information regarding the Private Growth component can be found in

the Appendix of this section.

B. Modifications to Component Structure

Modifications to the Broad Growth class’s component structure can take four forms:

i. Adding or deleting a specific investment strategy within a specific component;

ii. Adding or deleting a specific component;

iii. Establishing allocation levels and ranges among the components;

iv. Establishing strategy allocation levels and ranges within the components.

Modifications to the Broad Growth’s component structure will occur only with approval

of the Board of Trustees.

C. Components’ Allocations and Allocation Ranges

The Broad Growth class’s allocation targets and allocation ranges among its three major

components are as follows (as a percent of total Broad Growth class assets):

Long-term Broad Growth Class Component Allocation Policy

Component Lower Limit Allocation Target Upper Limit

Traditional Growth 20% 35.5% 50%

Stabilized Growth 20% 35.5% 50%

Private Growth 29%*

* Due to the illiquid nature of the Private Growth component, its allocation will be based on pre-established policy allocation ranges, and likely not fluctuate dramatically

Interim Broad Growth Class Component Allocation Policies

Target

Structure

7/1/2016

Target

Structure

1/1/2018

Target

Structure

1/1/2019

Target

Structure

1/1/2020

Target

Structure

1/1/2021

Traditional Growth 45% 43% 41% 38.5% 35.5%

Stabilized Growth 45% 43% 41% 38.5% 35.5%

Private Growth 10% 14% 18% 23% 29%

Total 100% 100% 100% 100% 100%


SECTION D PAGE | 4

D. Management of Components

To manage the assets assigned to the Broad Growth class components, the Board of

Trustees (“Board of Trustees” or “Board”) of the Employees’ Retirement System of the

State of Hawaii (“ERS”) utilizes a combination of active and passive external managers.

Per policy, the Board delegates the manager selection process to the ERS’s general

investment consultant (“General Investment Consultant”) and the ERS’s investment staff

(“Investment Staff”), but retains final decision authority for selecting managers for a

specific investment mandate. Investment Staff is also expected to manage the components’

allocations to align with their respective allocation targets over time. From time-to-time,

based on market dynamics and trends, Investment Staff has the discretion to vary each

respective component’s allocation away from the allocation target, but always within the

upper and lower limits as shown in the table under Section C. above. Investment Staff is

responsible for reporting to the Board component allocation levels that vary materially

from their allocation targets.

Within each component, assets are allocated across a series of mandates and/or investment

styles. In combination, these mandates and styles capture a broad, representative sampling

of the available investment opportunity set within the specified component. The

mandate/style allocations within each component are as follows:

Traditional Growth Component Allocation Policy

Long-only Public Equity – 100%

Global – 100%

Passive

Mid-Large Cap 100%

Small Cap 0%

Active

Mid-Large Cap 62%

Small Cap 38%

Total Passive 60%

Total Active 40%

Stabilized Growth Component Allocation Policy

Covered Calls –

17%

Public Extended Global

Credit – 17%

Cash-Secured Put-Writing –

34%

Passive 0% Passive 0% Passive 0%

Active 100% Active 100% Active 100%

Low Volatility Equity –

17%

Core Real Estate –

15%*

Credit –

0%*


Active 100% Active 100% Active 100% *See the Appendix of this section for further detail on the structure of the subcomponent


SECTION D PAGE | 5

Private Growth Component Allocation Policy*

Private Growth – 100%

Private Markets – 100%

Private Equity – 50%-100% Non Core Real Estate – 0%-50%

Passive 0% Passive 0%

Active 100% Active 100% *See the Appendix of this section for further detail on the structure of the Private Growth component

E. Components’ Managers and Managers’ Allocations

To manage the assets allocated to each strategic class and its underlying components, the

Board delegates investment authority to external investment managers (“investment

managers”). The General Investment Consultant and Investment Staff have joint authority

for identifying and selecting investment manager candidates for specific investment

mandates. The Board has final authority over the selection of specific managers for each

mandate. Investment Staff has the authority to manage the allocation to each investment

manager. Under this authority, Staff may reduce funding to one or more specific

manager(s) and/or increase funding to one or more specific manager(s) as long as the risk

profile of the component or sub-component is maintained. The investment manager

allocations within each component mandate are as follows:

Traditional Growth Component Manager Allocation Policy

Long-only Public Equity – 100%

Global – 100%

Within Passive (60%)

LGIMA (market cap) 55%

BlackRock (enhanced index) 45%

Within Active (40%)

QMA (mid-large cap) 35%

Longview (mid-large cap) 27%

Wasatch (small cap) 19%

Wellington (small cap) 19%


SECTION D PAGE | 6

Stabilized Growth Component Manager Allocation Policy

Covered Calls – 17% Public Extended Global Credit – 17%

Active – Gateway 100% Active – WAMCO 50%

Active – Tortoise Credit 30%

Active – PIMCO 20%

Cash-Secured Put-Writing – 34% Low Volatility Equity – 17%

Active – Gateway 33.33% Active – Robeco 50%

Active – Neuberger Berman 33.33% Active – TOBAM 50%

Active – UBS 33.33%

Core Real Estate – 15%* Credit – 0%*

Heitman 0-100%** Active – TBD TBD

Other 0%-33** *See the Appendix of this section for further detail on the structure of the sub-component

**Actual allocations will be determined by property dynamics, cash flows, and input from the ERS’s Real

Estate Consultant

Private Growth Component Manager Allocation Policy

Investment manager allocations are determined separately by the ERS’s Private Equity

and Real Estate Consultants. See the Appendix of this section for more detailed

information.


SECTION D PAGE | 7

D.3. Return Objectives & Risk Profile

A. Class Return Benchmarks

The ERS utilizes the custom target benchmark below to monitor the performance results

of the Broad Growth Class:

Traditional Growth 41% MSCI ACWI IMI ND +

Stabilized Growth

6.97% CBOE BXM +

3.49% BC Global Credit (Hedged) +

2.32% BC Global High Yield (Hedged) +

1.16% S&P LSTA Leveraged Loan +

6.97% CBOE PUT +

3.49% MSCI ACWI ex. U.S. Index ND +

3.49% 3-Month T-Bills +

6.97% MSCI ACWI Minimum Volatility ND +

6.15% NCREIF Fund Index – Open End Diversified

Core Equity (“NFI-ODCE”) (quarter lagged) Net +

Private Growth 18% MSCI ACWI IMI ND + 2%/year

The Broad Growth Class portfolio is expected to outperform the above blended benchmark,

net of fees, over a full investment cycle. An appropriate measure of an investment cycle

would be rolling 5-year periods. The Broad Growth Class portfolio should outperform its

benchmark, net of fees, over the majority of rolling 5-year periods.

The Traditional Growth component portfolio is expected to outperform the MSCI ACWI

IMI, net of fees, over the majority of rolling 5-year periods.

The Stabilized Growth component benchmark is a combination of nine underlying

benchmarks. Normalizing these benchmark weights to 100%, the Stabilized Growth

benchmark is:

17.0% CBOE BXM +

8.5% BC Global Credit (Hedged) +


2.83% S&P LSTA Leveraged Loan +

17.0% CBOE PUT +

8.5% MSCI ACWI ex. U.S. Index ND +

8.5% 3-Month T-Bills +

17.0% MSCI ACWI Minimum Volatility ND +


SECTION D PAGE | 8

15.0% NFI-ODCE (quarter lagged) Net

The Stabilized Growth component portfolio is expected to outperform the above blended


The Private Growth component portfolio is expected to outperform the MSCI ACWI

IMI+2%/year benchmark, net of fees, over the majority of rolling 10-year periods. A

longer measure of an investment cycle is used for the Private Growth component due the

long-term funding nature of investments within the component.

B. Class Risk Profile

In aggregate, the Broad Growth Class is the ERS’s most volatile investment class and is

the class that is most sensitive to economic growth trends. Based on current capital market

assumptions and the Broad Growth Class’s long-term structure, there is a 10% probability

this class will lose an estimated 19% of its capital within the next five years. Conversely,

there is also a 10% statistical probability that the portfolio could double in five years. This

degree of potential volatility is unique to the Broad Growth Class.

Each of the components exhibit varying degrees of volatility:

- The volatility of the Stabilized Growth component is expected to be approximately

two-thirds the volatility of the Traditional Growth component.

- The volatility of the Private Growth component is expected to be approximately

fifty percent greater than the volatility of the Traditional Growth component.

Based on this policy, Investment Staff can rebalance the components of the Broad Growth

Class (specifically, the Traditional Growth and Stabilized Growth components) to manage

the overall class’s expected volatility. Allocating away from the Traditional Growth

component and to the Stabilized Growth component will decrease the overall class’s

expected volatility while only marginally decreasing the overall class’s long-term expected

return. Conversely, allocating away from the Stabilized Growth component and to the

Traditional Growth component will increase the overall class’s expected volatility and

marginally increase the overall class’s long-term expected return. These volatility/return

characteristics are impacted, however, by the prevailing market environment and

opportunity set.

C. Component Risk Profiles

The ERS is expected to manage the Traditional Growth and Stabilized Growth component

portfolios by taking active risk (tracking error) around the respective benchmarks discussed

under Section D.3.A. above. Active risk within a specific component portfolio is the

aggregation of several risks taken/accepted by Investment Staff and/or ERS’s external

investment managers as they implement the component portfolios. Types of active risk


SECTION D PAGE | 9

include: security selection risk, sector/style bias risk, manager weighting risk, and

benchmark misfit risk. The allowable active risk ranges for the Traditional Growth and

Stabilized Growth components are:

Tracking Error Ranges – Key Broad Growth Class Components Component Allowable Tracking Error

Traditional Growth 2.5% - 3.5%/year

Stabilized Growth 3.0%-4.0%/year

Private Growth does not have an active risk threshold/budget due to the difficulty of

benchmarking private markets investments on a continuous basis. The two segments

above consist almost entirely of investments traded in the public markets.


SECTION D PAGE | 10

D.4. Manager Investment Guidelines

All investments and investment managers are subject to Section 88-119 (Investments), Hawai‘i Revised

Statutes (“HRS”), the Derivatives Policy and Watch Criteria in the Appendix of this section, and the

following guidelines:

A. Traditional Growth Manager Guidelines

Global Equity – Enhanced Index

Manager(s): BlackRock

All allowable securities are described in Section 88-119 (Investments), HRS, the

Derivatives Policy in the Appendix of this section, and the following guidelines:

Component: Traditional Growth

Benchmark: MSCI All County World Index ND (ACWI)

Max. Tracking Error Objective: 1.5% annualized Refer to appendix for Watch Criteria and Return Expectations

Active Risk Allocation Objective: security selection: minimum: 75%; systematic factors: maximum: 25%

Security Allowances/Restrictions:

- Cash equivalent portion shall not exceed 5%

- Individual securities shall not exceed 5% of the portfolio value where

the security constitutes less than 3% of the benchmark

- Individual securities shall not exceed benchmark weight + 2% where the

security constitutes more than 3% of the benchmark

- In aggregate, ETFs, ETNs, Promissory Notes, and Preferred Stock may

not exceed 15% of the portfolio value

- Rule 144a securities are allowable up to 10% as long as the securities

purchased are issued by a company that has conventional shares already

held in the portfolio

- Leverage and/or short positions are not allowed. Frictional short-term

settlement related positions will not be considered leverage.


SECTION D PAGE | 11

Global Equity – Active Mid-Large Cap

Manager(s): Longview





Tracking Error Assumption: 5.5% annualized Refer to appendix for Watch Criteria and Return Expectations




- Individual securities shall not exceed 15% of the portfolio value





held in the portfolio.

Manager(s): QMA





Tracking Error Assumption: 4.5% annualized Refer to appendix for Watch Criteria and Return Expectations












held in the portfolio.


SECTION D PAGE | 12

Global Equity – Active Small Cap

Manager(s): Wasatch

Wellington




Benchmark: MSCI All County World Small Cap Index ND (ACWI Small Cap)














- Leverage and/or short positions are not allowed.


SECTION D PAGE | 13

B. Stabilized Growth Manager Guidelines (excluding Core Real Estate Managers)

Covered Calls - Active

Manager(s): Gateway Investment Advisers



Component: Stabilized Growth

Benchmark: CBOE S&P 500 BuyWrite Index (BXM)






the security constitutes less than 3% of the benchmark, excluding

options


security constitutes more than 3% of the benchmark, excluding options


not exceed 15% of the portfolio value, unless such securities are used to

provide broad market exposure





SECTION D PAGE | 14

Global Put-Writing - Active

Manager(s):

Gateway Investment Advisers

Neuberger Berman

UBS




Benchmark:

50% CBOE S&P 500 PutWrite Index (PUT)

25% MSCI ACWI ex. U.S. Index ND

25% 3-Month T-Bills




- Unhedged (i.e., MSCI USD) and hedged (i.e., local index) options are

both permitted

- Put options are the only permitted option type

- Options must only be sold on diversified indices/ETFs

o Diversified is defined as broad market indices and sectors

- Options may only be purchased to close existing short positions

- Options must be exchange-traded or otherwise backed by a qualified

central clearinghouse

- Portfolios should target selling options on 100% of the portfolio’s

collateral balance (i.e., 100% coverage) at all times

o The maximum liability/loss from the short options positions may range from

97%-101% of the collateral balance

- All non-margin-related collateral shall consist of USD cash and/or U.S.

Treasury bills/notes/bonds with 3-years or less until maturity

o Custodian provided cash sweep vehicles are also permitted

- Cash other than USD may be held if options within the portfolio require

non-USD collateral as margin, as determined by the brokers/exchanges

- Currency futures/forwards positions are only permitted for unhedging

local index put options positions

o Defined as adding long currency exposure to short local index option positions

(e.g., buying GBP after selling FTSE 100 Index put options)

- Long/short positions in equity index futures and ETFs are allowable for

transition/equitization and delta management purposes

o These positions should not represent strategic allocations in the portfolio

- Regional weightings (% of notional):

o 30-70% U.S. | 20-60% EAFE+Canada | 0-30% EM

o For the purpose of regional weighting calculations, subsets of the above regions are

included in the calculation (e.g., 10% of the portfolio’s notional value in FTSE 100 options would qualify as 10% EAFE+Canada)

o Regions/countries are determined by MSCI


SECTION D PAGE | 15

Global Low Volatility Equity

Manager(s): Robeco




Benchmark: MSCI ACWI Minimum Volatility Index ND (ACWI Min Vol)














Manager(s): TOBAM




Benchmark: MSCI ACWI Minimum Volatility Index ND (ACWI Min Vol)















SECTION D PAGE | 16

Extended Global Credit

Manager(s):

Western Asset Management Company (WAMCO)

Pacific Investment Management Company (PIMCO)

Tortoise Credit




Benchmark:

50% BC Global Credit (Hedged) +


16.66% S&P LSTA Leveraged Loan

Max. Tracking Error Objective: 5.0% annualized | Refer to appendix for Watch Criteria and Return Expectations



- Rating agencies: Moody’s, Standard & Poor’s, and Fitch

- Securities rated by all three agencies are assigned the middle rating o For example, for a security to be rated A it must be rated at least A by two of the

three agencies

- Securities rated by only two agencies are assigned the most conservative

rating

- Securities rated by only one agency are assigned that rating

- Stock (converted common and preferred) shall not exceed 10% of the

portfolio value

- Converted common stock shall not be held for longer than 180 days

- Individual issuer shall not exceed 5% of the portfolio value at time of

purchase o Excludes Government Supported securities. Specific mortgage pools and trusts are

considered separate issuers, and each tranche within a CMO is considered a

separate issue.

Government Supported = Supranationals, U.S. Treasuries, sovereign debt of

OECD governments, U.S. agencies and government sponsored enterprises,

and equivalently-rated agencies of OECD governments.

- Minimum issuance size is $100 million Excludes Agency MBS

- Quality: o Non-Investment Grade / Unrated = 0-75%

- Non-Benchmark Markets (ex cash and repurchase agreements): o Non-Benchmark (excluding Government Supported) = 0-40% o Non-Benchmark Government Supported = 0-40% Benchmark markets are based on currency denomination and security type.

- Foreign Currency: o Max. Net* = 40%

o Max. Gross* = 80%

- Note: Managers are required to segregate and summarize explicit

currency exposures in the reporting process

- Acceptable Securities: Repurchase agreements with Government

Supported securities as collateral, money market instruments & funds,

supranationals, convertibles, bank loans, EMD, non-leveraged

structured notes, credit-linked notes, PIKs and PIK-toggles, CMOs

- Prohibited Securities: Mortgage Derivatives (IOs / Pos / Inverse

Floaters), Re-REMICs

*Net foreign currency exposure is the amount of offsetting currency exposure versus a portfolio’s or benchmark’s cash market security positions. For example, a local-market sector amounting to a 5% portfolio weighting

offset by a (5%) short position in the commensurate local currency would result in a zero net foreign currency exposure. Net foreign currency exposure will be measured as the absolute value of all country-level net currency

positions (long and short) versus the U.S. Dollar. Both long and short foreign currency positions may be held without owning securities denominated in such currencies. Gross foreign currency exposure will be measured as

the absolute value of all country-level currency positions (long and short) versus the U.S. Dollar. Both long and short foreign currency positions may be held without owning securities denominated in such currencies.


SECTION D APPENDIX 1 PAGE | 17

B R O A D G R O W T H : A P P E N D I X



Appendix: Derivatives Policy

Derivatives may be used in the ERS portfolio as a substitute for a cash market security, risk control, income (e.g.

Covered Calls), cost reduction, or liquidity management. Derivatives are not permitted for purposes of speculation.

Any derivative investment not explicitly authorized below is prohibited.

Where derivatives are used as substitutes for a specific cash security or set of cash securities, the return

volatility of the combination of the derivative and associated cash position shall be equivalent to the

unleveraged cash security or securities underlying the derivative instrument.

When options are used for income and risk control (e.g. Covered Calls), the notional value of the

options may not exceed the total value of the underlying securities.

Managers shall mark-to-market their derivative positions daily.

Permitted Instruments:

Futures – stock index futures, stock and bond futures, money market futures, and currency futures

where the manager has the authority to invest in the underlying or deliverable cash market

security.

Options – options on stocks, indices, ETFs, and bonds (including interest rate caps and floors).

Options on futures, swaps, and currencies are allowed for those managers who have permission to

invest in the comparable cash instruments.

Currency forwards – only those managers who have the authority to invest in the underlying cash

market instrument.

Swaps (Extended Global Credit managers) – where the manager has the authority to invest in the

underlying cash market instrument. Minimum counterparty rating: A-

Futures contracts must be CTFC (Commodity Futures Trading Commission) approved and exchange

traded.

Options may be either exchange traded or over-the-counter (OTC) subject to counterparty guidelines as

noted.

Managers may purchase back options in order to close out positions.

Counterparties to OTC traded instruments (options and forwards) must be rated investment grade or better

as determined by at least one major rating agency.

Cross-hedging is not permitted by international equity managers; however, as it is a standard practice for

non-U.S. bond managers, it is allowed for Extended Global Credit managers. These credit managers may

also use certain developed-market currencies as proxies for otherwise illiquid emerging-market

currencies. In such cases, use of such proxies will be disclosed through the ongoing reporting process.

The counterparties for foreign currency derivatives must be rated A- or equivalent.

On an annual basis, all investment managers shall provide a summary of the derivatives used and the

reasons for their use. This summary shall be the basis for verification that the investment managers are

generally complying with the objectives and constraints of the investment policy. The investment

consultant shall elicit responses on each manager’s policy in the form of a letter.

On a daily basis the custodian bank shall examine all manager derivatives purchases for prohibited

derivatives. Should any prohibited derivatives be found, the custodian bank should promptly notify Staff

and instruct the manager to sell the prohibited derivatives. The custodian bank will also value and

monitor all derivatives and the trades from which they emanate.



0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00%

Watch Threshold -0.41% -0.82% -1.23% -1.63% -2.04% -2.45% -2.86% -3.27% -3.68% -4.08%

Impled Excess Return 0.17% 0.33% 0.50% 0.67% 0.83% 1.00% 1.17% 1.33% 1.50% 1.67%

Watch Threshol -0.17% -0.33% -0.50% -0.67% -0.85% -1.02% -1.20% -1.38% -1.55% -1.73%


Watch Threshold 0.995 0.991 0.986 0.981 0.976 0.971 0.966 0.961 0.956 0.951


5.50% 6.00% 6.50% 7.00% 7.50% 8.00% 8.50% 9.00% 9.50% 10.00%

Watch Threshold -4.49% -4.90% -5.31% -5.72% -6.13% -6.53% -6.94% -7.35% -7.76% -8.17%


Watch Threshol -1.92% -2.10% -2.29% -2.47% -2.66% -2.85% -3.04% -3.24% -3.43% -3.63%


Watch Threshold 0.946 0.940 0.935 0.929 0.924 0.918 0.912 0.907 0.901 0.895


Long-Term

(5-year)

Short-Term

(1-year)

Medium-Term

(3-year)

Long-Term

(5-year)

Tracking Error

Tracking Error

Short-Term

(1-year)

Medium-Term

(3-year)

Appendix: Watch Criteria and Implied Excess Returns (annualized)

Short-Term Criteria (ex Private Growth mandates):

Performance below the threshold for 3 consecutive months.

Medium-Term Criteria (ex Private Growth mandates):


Long-Term Criteria (ex Private Growth mandates):

VRR (Value Relative Ratio) below the threshold for 6 consecutive months.

VRR = (1 + manager cumulative return) / (1 + benchmark cumulative return)

The Watch Thresholds and Implied Excess Returns assume an Information Ratio of 0.33.

Rationale:

The establishment of an assumed information ratio (excess return / tracking error) is important in order to

develop consistent active risk taking evaluation criteria across the portfolio. Investors should expect a

positive return to active risk taking, or they should not do it.

Absolute returns to volatility (Sharpe ratio) for a traditional 60/40 portfolio over the long-term has been

between 0.3 and 0.4, and was approximately 0.33 over the 1973 to 2010 time period. Intuitively then, if

an uncorrelated active strategy could be isolated, it should be expected to contribute at this level of return

to volatility in order to be additive to portfolio return to risk.

There is no certainty about future active returns, correlation of those returns to market risks, distributions

of those active returns, or even the future return to market risks. Given all of this uncertainty, establishing

an expected information ratio requirement for active managers to evaluate their performance is useful. A

0.33 information ratio across public market strategies provides a reasonable and objective level based on

the considerations outlined above.



Performance-related criteria for the Private Growth component is specified within the corresponding component section.

TABLE OF CONTENTS

Page

1. REAL ESTATE INVESTMENT OBJECTIVES ................................................................................ 21

A. INVESTMENTS IN REAL ESTATE .......................................................................................... 21

B. CORE STRATEGIC ALLOCATION .......................................................................................... 21

C. CORE PORTFOLIO RETURN OBJECTIVES ........................................................................... 21

2. PROGRAM MANAGEMENT ............................................................................................................ 22

A. OVERVIEW .................................................................................................................................. 22

B. PARTICIPANT ROLES AND RESPONSIBILTIES .................................................................. 22

C. PORTFOLIO COMPOSITION..................................................................................................... 23

D. INVESTMENT AND RISK MANAGEMENT ........................................................................... 23

3. REAL ESTATE INVESTMENT PROCESS ...................................................................................... 26

A. MANAGER SELECTION ............................................................................................................ 26

B. TRANSACTION REVIEW AND CLOSING – SEPARATE ACCOUNTS .............................. 26

C. ASSET MANAGEMENT – SEPARATE ACCOUNTS ............................................................. 26

D. DISPOSITION – SEPARATE ACCOUNTS ............................................................................... 26

E. COMMINGLED FUND INVESTMENTS .................................................................................. 27

4. CONTROL AND MONITORING SYSTEMS ................................................................................... 28

A. ANNUAL REPORTING REQUIREMENTS .............................................................................. 28

B. QUARTERLY REPORTING ....................................................................................................... 28

C. PROPERTY VALUATIONS ........................................................................................................ 29

D. AUDIT PROCESS ........................................................................................................................ 30

E. ACCOUNTING AND CASH MANAGEMENT ......................................................................... 30

F. QUANTITATIVE GUIDELINES FOR REAL ESTATE MANAGER “WATCH LIST” OR

TERMINATION ........................................................................................................................... 31

Exhibits

Real Estate Investment Brief Format – Exhibit 1

Real Estate Investment Manager Reporting Requirements – Exhibit 2

Real Estate Separate Account Tactical Business Plan Outline – Exhibit 3

Real Estate Asset Management Plan – Exhibit 4

APPENDIX: CORE REAL ESTATE SUB-COMPONENT



1. Real Estate Investment Objectives

A. Investments In Real Estate

The Employees’ Retirement System of the State of Hawaii (“ERS”) completed a strategic

allocation study for the investment of its assets. This analysis demonstrated that, over the

long term, inclusion of investments in private equity real estate and debt positions in real

estate properties would enhance the ERS’s expected portfolio investment characteristics

while reducing expected total portfolio volatility.

In general, the ERS desires to obtain the optimum return on the portfolio consistent with

the assumption of prudent risk. While safety of principal is given primary consideration,

the ERS recognizes the need to use active asset management strategies in order to obtain

the highest attainable total investment return (income plus appreciation) within the ERS’s

framework of prudence and managed risk.

Core real estate investments of ERS shall be made in a manner consistent with the fiduciary

standards of the prudent person rule: (1) to safeguard and diversify the core real estate

portfolio; and, (2) for the sole interest of the participants and their beneficiaries. The

selection of investment managers and development of investment policy will be guided to

enhance diversification within the portfolio of the ERS’s core real estate investment

program (“Core Real Estate Investment Program”) thereby limiting exposure to any one

investment, organization, real estate property type and geographic region (Refer to Section

II: Program Management).

1. Real Estate Defined - Real estate assets are defined as those investments that are

unleveraged or leveraged, private equity or debt positions in real property. The

ownership structure(s) should be consistent with any rules, regulations, or law, as

applicable, governing the ERS. The ERS will pursue both discretionary separate

account investment management and discretionary commingled fund investment

management for its core real estate allocation.

B. Core Strategic Allocation

The ERS allocation to real estate shall remain within the limits authorized by the ERS

Board of Trustees. Core real estate allocations should be in line with those that are detailed

in their respective categories referred to in Section D: Broad Growth Program. Core real

estate is classified in the Stabilized Growth allocation.

C. Core Portfolio Return Objectives

The core real estate return objectives will follow their respective assignments as detailed

in Section D.3. Return Objectives & Risk Profile.



2. Program Management

A. Overview

In compliance with current ERS investment philosophy, the Real Estate Investment

Program will primarily utilize discretionary separate account relationships and

discretionary commingled fund investment vehicles that are sponsored by real estate

investment managers (“Investment Managers”). Under this program, the Investment

Managers acquire, operate and dispose of real estate assets in accordance with a work

assignment that is outlined in their investment management contract with the ERS (the

“Contract”) and in the Annual Tactical Plan for separate accounts and the fund documents

for commingled funds. The Contract describes the acceptable property types, geographic

restrictions, investment structures, leverage and other specific investment parameters. The

Annual Tactical Plan is the Investment Manager’s “working plan” for each fiscal year and

must be reviewed by Investment Staff and Real Estate Consultant (Refer to Exhibits

accompanying this Section) and approved by the Board of Trustees. Commingled fund

documents typically refer to the fund’s offering memorandum or private placement

memorandum, limited partnership or LLC membership agreement, and subscription

agreement.

B. Participant Roles and Responsibilities

The ERS’s Real Estate Investment Program shall be implemented and monitored through

the coordinated efforts of the Board of Trustees; through the Investment Staff; the ERS’s

general investment consultant (“General Investment Consultant”); the ERS’s real estate

consultant (“Real Estate Consultant”); the Investment Manager(s). Specific

responsibilities that fall outside the general responsibilities highlighted in Section B.5. are

listed below:

1. Investment Manager - Qualified real estate organizations, registered as Investment

Advisors under the 1940 Act that provide institutional real estate investment

management services to the ERS. ERS may invest in commingled fund vehicles that

are not registered, however, it is preferred that the commingled fund be sponsored

and/or managed by a Registered Investment Advisor.

Separate Account Manager Responsibilities - The separate account Investment

Manager, acting as a fiduciary on behalf of ERS, acquires, manages and disposes

of real estate properties and/or originates or acquires, manages, and realizes upon

real estate debt investments in accordance with the annual Tactical Plan and

Contract.

Commingled Fund Manager Responsibilities – The commingled fund

Investment Manager, acting as a fiduciary on behalf of ERS, acquires, manages

and disposes of real estate properties and/or originates or acquires, manages, and

realizes upon real estate debt investments in accordance with the terms of the

investment vehicle documents.



C. Core Portfolio Composition

1. Core Portfolio - Core investments include equity or debt investments on existing,

substantially leased income-producing traditional property types located

principally in metropolitan areas that exhibit reasonable economic diversification.

Core properties, therefore, must have the following characteristics:

Traditional institutional quality property types including office, industrial,

retail and multifamily; also included are medical office, senior housing,

storage, and student housing properties that demonstrate core

characteristics;

Operating and stabilized properties that demonstrate predictable income

flows with a high proportion of anticipated total return arising from current

income and cash flow;

At least 70% leased upon purchase of the asset;

Located in institutional markets and in economically diversified

metropolitan areas;

High credit quality tenants and a staggered lease maturity schedule;

Quality construction and design features;

Reasonable assurance of a broad pool of potential purchasers upon

disposition;

Properties requiring quality asset and portfolio management but not

requiring specialized operating expertise which is not readily available in

the market;

Investments structures using all cash or low leverage. Leverage is limited

to 50% on each investment;

Total gross return expectations between 6% and 8% per year.

D. Investments and Risk Management

The ERS shall manage the investment risk associated with real estate in several ways:

1. Institutional Quality - All assets within the Core portfolio must be of institutional

investment quality as evidenced by a history of institutional investment in similar

properties; expert analysis which supports the economic viability of the market;

high quality construction and design features; and a current or potentially

competitive position within the property’s immediate market area.

2. Diversification - The real estate portfolio shall be diversified by geographic region

and property type. Diversification reduces the impact on the portfolio of any one

investment or any single Investment Manager’s style to the extent that an adversity

affecting any one particular area will not impact a disproportionate share of the

total portfolio.



Target Portfolio

Although the real estate portfolio has been split between stabilized growth

allocation (where core real estate resides) and private growth allocation (where

noncore real estate resides, the long-term real estate strategy is for the ERS real

estate portfolio to be diversified by geographic regions and property type taking

into account the following diversification guidelines:

Property Type - The Plan seeks to minimize the risk of its real estate portfolio

by allocating its assets across the spectrum of property types. The real estate

portfolio shall be diversified with the majority of investments comprised of

the four traditional property types: office, industrial, retail, and multifamily

(apartment). No single traditional property type shall account for greater

than 50% of the portfolio. In addition, the allowable range of property type

allocations will be 0.5x – 1.5x the NFI-ODCE’s weight in each property

type. Other property types, such as hotels, motels, residential housing,

senior housing, self storage, and raw land are allowed but (on a combined

basis) should not exceed 20% of the core real estate portfolio.

Geographic - The Plan seeks to minimize the risk of its real estate portfolio by

allocating its investments across the geographic spectrum. Within the

United States, the allowable range of geographic allocations will be 0.5x –

1.5x the NFI-ODCE weight in each region. International Investments (Non

US and Canada) will range between 0-20% of the core real estate portfolio.

3. Ownership Structure - The ownership structure for Core investments includes

leveraged and unleveraged equity and debt investments owned 100% by ERS or

owned jointly with Suitable Investment Partners. “Suitable Investment Partners”

include public, corporate and union pension plans, foundations and endowments,

insurance company general accounts or separate accounts, and other tax-exempt

institutions, having the same or greater standards of fiduciary care and

responsibility as those imposed by ERS guidelines. When dealing with non core

investments that are directly owned, Operating Partners shall be added to the list

of “Suitable Investment Partners.” The ownership structure of non core assets

within commingled funds will be governed by the fund documents.

4. Leverage - Leverage may be utilized in a constrained manner in the Core portfolio

in order to enhance yields of the various investments and/or facilitate the

diversification of the portfolio. The use of debt must result in positive leverage

where cash flow is in excess of debt service. The total expected return to ERS over

the term of the investment must be expected to increase a minimum of 2 basis

points for each 1% of leverage, as a result of leverage. For example, leverage

returns on an acquisition with 50% debt should be higher than the unleveraged

returns for the same property by a minimum 100 basis points. The total level of

debt for any single investment will not exceed fifty percent (50%) of the value of

that asset for core investments. Total portfolio debt will be limited to forty percent

(40%) in the core portfolio. The single investment debt level will be measured for

compliance at the point leverage is added to the portfolio. The total portfolio debt

levels will be measured for compliance at the point leverage is added to the

portfolio or a portfolio asset is purchased or sold.



5. Manager Concentration – ERS shall limit its exposure to any single manager.

No single Investment Manager shall be permitted to manage more than 35% of the

total allocation to real estate at the time of investment (i.e., purchase). In the case

of the Separate Account Manager(s), concentrations are likely to exist, and be

allowed, during build up or wind down periods of such accounts.

6. Investment Size – There is no minimum investment size. The maximum net

investment in a single property within the separate account shall be limited to 33%

of the allocation to the core real estate program at the time of investment. The

maximum investment in any single commingled fund shall be limited to 25% of

the allocation to the core real estate program at the time of investment. The ERS’s

investments in a single commingled fund shall not exceed 20% of the total net

market value of the commingled fund at the time of investment. If the commingled

fund is in the process raising assets (versus being an open-ended fund), the 20%

threshold will be based on target fund size.



3. Real Estate Investment Process

A. Manager Selection

In an effort to maintain program simplicity and ensure appropriate underwriting of

investment management organizations, the ERS shall utilize only ERS approved real estate

investment management firms for the acquisition, asset management and disposition of

property and origination, management, and realization of debt investments. In addition to

the existing separate account Investment Managers, the ERS has approved a program of

commingled fund investing. Each Investment Manager will be provided a specified capital

allocation. Investment Manager capital commitments shall periodically be balanced in

accordance with the overall real estate strategic allocation objectives as discussed

elsewhere in the real estate sections of the Broad Growth policy.

B. Transaction Review And Closing - Separate Accounts

1. Investment Identification - Upon identifying a specific investment that meets the

program guidelines and Tactical Plan objectives, the Investment Manager must provide

to the Investment Staff and Real Estate Consultant, a written summary of the property

characteristics, investment structure and notification of joint venture partners and/or

investment partners in the format provided in Exhibit 1.

2. Property Closing and Funding - Once the Investment Manager identifies an

investment that meets portfolio objectives, the Investment Manager shall provide to

the Investment Staff and Real Estate Consultant a Critical Dates list which includes

scheduled funding dates, wire transfer instructions and other important timing

information. In addition, the Investment Manager shall prepare a Closing Report as

appropriate. Upon close of the investment, the Investment Manager shall provide to

ERS a summary of all uses of capital funded by the ERS.

C. Asset Management - Separate Accounts

In conjunction with its asset management responsibilities, the Investment Manager must

comply with the reporting requirements as outlined in Exhibit 2. Revisions to the original

ten year pro forma and capital budget that require unscheduled capital fundings must be

presented to the Investment Staff for review; however, it is not necessary to present to staff

unscheduled capital fundings that were already described in the annual property plans.

Refinancing or partial dispositions that were not approved as a part of the Annual Tactical

Plan must also be presented to the Investment Staff.

D. Disposition – Separate Accounts

Annually, the Investment Manager must review each property managed by it on behalf of

ERS and complete a “hold” or “sell” analysis. Assets targeted for sale are identified and

documented and a brief explanation of the sell decision and strategy is provided to the

Investment Staff, the Real Estate Consultant, and the Board at the annual Tactical Planning

presentation. In addition, the Investment Manager must submit to the Investment Staff and

Real Estate Consultant notification of any unsolicited sales offers. Once an offer is

accepted by the Investment Manager, the Investment Staff and the Real Estate Consultant

must be provided with a Critical Dates list that details the disposition activities.



E. Commingled Fund Investments

The ERS does not anticipate using the commingled fund vehicle for additional Core

investing unless a specific niche strategy makes it otherwise compelling (e.g., specialty

debt investing). Rather, separate accounts are the preferred vehicle for Core investments.

The selection process used to invest in commingled funds is similar to the process used to

retain separate account Investment Managers. Selection criteria for commingled funds

shall include minimally conflicted fee structures and maximum investor controls. In

addition, the ERS shall use similar strict control and monitoring systems to evaluate the

commingled fund Investment Managers as used for evaluating the separate account firm.



4. Control and Monitoring Systems

In real estate investing, separate and distinct from other strategic classes, the Investment Manager

has direct control over the operations of the assets. This inherent conflict of interest contributes to

the lower volatility associated with the strategic class but also creates a need for greater oversight

by the ERS. The Board of Trustees shall be notified by the Investment Staff and the Real Estate

Consultant of Investment Manager reporting problems, significant organizational changes such as

mergers, and prolonged under-performance. Investment Managers performing below expectations

in any of the before mentioned areas shall be placed on the “watch list” outlined below. All

Investment Managers will be subject to an annual review in Hawai‘i and may also be called in by

the Investment Staff or Board for a special review. Finally, the ERS also recognizes that it may

elect to terminate separate account Investment Managers within thirty (30) days for “cause” as

outlined in the Contracts. The ERS shall manage the Real Estate Investment Program in the

following manner:

A. Annual Reporting Requirements

Separate Account Investment Managers

1. Tactical Plans - Annually, the separate account Investment Manager prepares a

Tactical Business Plan, an outline of which is in Exhibit 3. In the Tactical Plan, the

Investment Manager outlines its targeted investment plan including the basis upon

which targets have been established. The Plan must include property/investment type,

investment structure, return expectations and exit strategies as well as any other

pertinent strategy specific parameters. This Plan is to be completed or revised every

year and submitted to the Investment Staff and the Real Estate Consultant. The plan

shall be presented to the ERS Board of Trustees in July of each year, unless otherwise

directed by the Investment Staff or Board, and, if appropriate, shall be approved by the

Board.

2. Asset Management Plans - The separate account Investment Manager must also

prepare annual asset management plans for each managed by the firm and owned by

the ERS. Asset management plans include property-specific operating budgets;

estimates of cash to be distributed to the ERS, management fees, debt service, lease

expirations and rollover, and all other relevant property information. A sample outline

is included as Exhibit 4. Asset management plans are due to the ERS’s Board of

Trustees in July of each year along with the Tactical Plan(s). When submitting the

annual asset management plan, the Investment Manager should review any significant

line item variances (greater than 10% and $25,000) from the prior year.

B. Quarterly Reporting

1. On a quarterly basis, the Consultant will prepare a Performance Measurement Report

which is a comprehensive report on and evaluation of each investment and/or asset,

Investment Manager. The evaluation shall provide such information as may be

required by the ERS to understand and administer its investments and Managers.

The content of the report shall include attributes for the assets individually (separate

accounts), the investment managers and the total portfolio including, but not limited

to: income, appreciation, gross and net returns, cash-flow, internal rate of return,



diversification, comparisons to relevant industry performance indices and information

reporting standards, and real estate investment policy compliance. Each investment

will be reviewed for significant events and projected performance and an opinion

provided with respect to Manager performance. Budget and Management Plan

variances, as reported by Separate Account Managers, will also be provided upon

request.

The Performance Measurement Report will be presented to the ERS’s Board of

Trustees within ninety (90) days following the last day of each quarter, except for year-

end reporting which will be prepared and forwarded to ERS within 180 days following

year-end.

Performance Measurement - Within 45 days for separate accounts and 60 days for

commingled funds of the quarter close, the Investment Manager is required to submit

to the Real Estate Consultant an investment position work sheet and distribution

worksheets for use in the calculation of performance figures for that period.

2. Operations Report - The Investment Manager shall analyze financial statements

quarterly comparing budgeted operations to actual investment performance. This

analysis must be available at Investment Staff’s request within 60 days of the quarter

close.

C. Property Valuations

1. Valuations/Appraisals – Valuations/Appraisals shall be conducted in accordance

with the ERS approved Investment Manager contracts (or commingled fund

documents).Investment Staff, on behalf of the ERS, reserves the right to obtain and

review the list of appraisers and their qualifications. Generally, ERS recommends the

following appraisal policy for its commingled and separate account managers.

a. Commingled Funds - Investment Managers sponsoring commingled fund

vehicles in which ERS may own or consider acquiring an interest should include

in the offering documents a valuation/appraisal policy detailing internal policies

that are independently audited on at least an annual basis or such that independent

MAI valuations are also conducted at least annually. If fees are paid based on

“market value” of an investment, then in no case should annual independent MAI

appraisals be waived.

b. Separate Accounts - For separate account structures: all investments in account

an will be marked to market quarterly by the separate account manager and

independently appraised annually by a qualified expert (certified MAI). All

valuations may be used for performance measurement purposes. Separate account

managers should adhere to the most recent version of the NCREIF PREA

Reporting Standards established jointly by the National Council of Real Estate

Investment Fiduciaries (“NCREIF”) and the Pension Real Estate Association

(“PREA”) (“Reporting Standards”). Separate Account Managers should provide

quarterly, written certification of compliance with these standards.

2. Performance Measurement - For performance measurement purposes, both the MAI

appraiser’s and the Investment Manager’s interim internal estimates of value will be

used to calculate returns.



3. Notification of Variance - Should the appraised value of any separate account asset

vary by more than 10% of the Investment Manager’s internal appraised value, the

Investment Manager must provide to the Investment Staff and the Real Estate

Consultant a written explanation for the variance. This report is due to Investment

Staff within 30 days of the final property appraisal.

D. Audit Process

1. Unrelated Business Income Tax (“UBIT”) - As a tax-exempt entity, the ERS hereby

instructs its Investment Managers to avoid transactions generating UBIT. Should ERS

be at any time invested in real estate or other assets that result in UBIT, the Investment

Manager is to provide immediate notification and an evaluation of the financial impact

to the Investment Staff who will then provide a report to the Board.

2. Audited Financial Statements - On an annual basis, the Investment Manager will

provide ERS with a combined audited financial statement for the total portfolio it

manages, to be prepared by a nationally recognized audit firm. The auditor shall

complete an income statement, balance sheet and changes in cash position analysis.

E. Accounting and Cash Management

1. Accounting Policies - All accounting data shall be computed in accordance with

generally accepted accounting principles prepared on a current value basis, not

historical cost accounting. Therefore, the carrying value of real estate assets shall be

adjusted annually to reflect the most recent current value based on the most recent

independent appraisal value or internal estimate of value. Accrual based accounting is

also generally used to allocate revenues and expenses to the appropriate periods.

2. Cash Management - The Investment Manager shall provide strict control over cash

transactions and balances ensuring that all excess funds are continually invested in

accordance with the ERS’s approved specifications as outlined in the manager’s

Contract. Cash balances will be swept to an account designated by ERS in compliance

with a previously agreed-upon schedule and in accordance with maximum balance

restrictions.



F. Quantitative Guidelines for Real Estate Manager “Watch List” or

Termination

The performance of the Board’s Investment Managers will be monitored on an ongoing

basis. The Board may place an Investment Manager on a “Watch List” or terminate a

manager at any time.

Investment Managers may be terminated or placed on a “Watch List” for a variety of

reasons: personnel changes, violation of policy and investment guidelines,

underperformance, strategic allocation changes and non-disclosure of material

information. The ERS has two clearly stated investment portfolio performance objectives:

the preservation of capital and consistent positive returns. These “Watch List”/termination

guidelines were formulated with these objectives as a foundation. Various factors should

be taken into account when placing a manager on a “Watch List” or recommending

termination. These can be separated into two broad categories - qualitative and quantitative

factors. The former focuses on personnel, organizational and legal issues while the latter

addresses performance. Qualitative factors are detailed in Section C: D. The Quantitative

Factors for real estate managers are detailed below.

When possible, the Board will issue a warning letter to underperforming Investment

Managers prior to placement on the “Watch List”. However, the Board may place an

Investment Manager on the “Watch List” at any time whether or not a warning letter has

been issued. Placing an Investment Manager on the “Watch List” is an intermediate step

towards either resolving the problem or terminating the Investment Manager. Investment

Managers may only be removed from the “Watch List” under these two conditions.



Real Estate Manager Watch List Guidelines - Quantitative Factors

Below are the quantitative factors to be considered in determining the appropriateness of terminating an

Investment Manager or placing the Investment Manager on the “Watch List.”

PERFORMANCE TEST

BENCHMARK

FAIL CRITERIA

Test 1:

Peer group comparison, for

trailing 3 and 5 years

Performance compared to the

NCREIF Fund Index – Open

End Diversified Core Equity

(“NFI-ODCE”)

Fail if cumulative performance is at 65%

percentile or lower over relevant time

frames.

Test 2:

Peer group comparison of

income for trailing 3 and 5

years

Performance compared to the

NCREIF Fund Index – Open

End Diversified Core Equity

(“NFI-ODCE”) index

Fail if cumulative performance is at 65%

percentile or lower over relevant time

frames.

The quantitative guidelines above refer to core separate accounts and a minimum time frame of three years.

Any underperformance for three years relative to any or all of the above referenced benchmarks should

trigger a review with the corresponding Investment Manager. Commingled fund managers will be evaluated

against the stated return objective of the fund at the time of the original investment (as included in the fund

documents). All of the qualitative criteria should be reviewed along with an explanation of the

underperformance from the manager.

The explanation of underperformance is to be accompanied by a plan to resolve the performance issues.

The plan should include specific objectives that can be measured by the Board and an appropriate timeframe

to accomplish the objectives. The Board can choose to allow the Investment Manager to resolve the issues

or terminate.



EXHIBIT 1


REAL ESTATE INVESTMENT BRIEF FORMAT

Date:

Manager:

Property Name/Property Location:

Property Type:

(Scheduled) Funding Date(s) and Amounts (Net Investment)df

Third Party Debt:

Gross Investment:

Investment Structure:

Investment Partners and Ownership Share:

Expected Return (Year 1 Cash-On-Cash and Nominal IRR both gross and net of fees):

Investment Summary: Elaborate on sellers, investment structure, and major business points.

Real Estate Description: Describe the competitive market area, improvements, and major tenants (if

applicable); when available include maps, aerial and surface pictures of building interior and exterior.

Expected Return: In addition to the Investment Manager’s base case pro-forma, include a forecast that

is consistent with the investment strategy utilizing the ERS’s CPI assumption and both before and after

fee scenarios.

Pro Forma Assumptions: Describe key assumptions such as investment period, growth rates and

residual capitalization rate.

Investment Strategy: Outline the real estate investment strategy including a review of the anticipated

future hold term, financing, development, or redevelopment plans, and any other relevant issues. Also,

discuss the investment’s classification as core or specialty and the associated risk level (low, moderate,

high).

Major Investment or Property Risks: List the major investment risks on a market, property, tenant and

transaction level.

Potential Conflicts of Interest: Discuss any potential conflicts of interest and how they will be resolved.

Program Compliance: Discuss the acquisition or disposition rationale and its consistency with the

program guidelines, the current Tactical Plan and other governing documents.



EXHIBIT 2


REAL ESTATE SEPARATE ACCOUNT INVESTMENT MANAGER

REPORTING REQUIREMENTS

REPORT DUE DATE RECEIVER COMMENTS

ACQUISITION

1. Investment Brief As Identified Staff5 Copy to Consultant

2. Critical Dates List 3 Weeks BF Close Staff Provide ASAP

3. Closing Report Before Closing Staff As Required

4. Sources/Uses of Capital Upon Closing Staff For Each Capital Call

DISPOSITION

1. Unsolicited Sales Offer As Occur Staff Report as Received

2. Critical Dates List Offer Accepted Staff Provided ASAP

ANNUALLY

1. Tactical Plan Annually Staff Governs Ensuing Year

2. Annual Asset Plans Annually Staff Governs Ensuing Year

4. External Financial Audits After Fiscal Year End Staff Nationally Recognized Firm

5. Independent Appraisals Anniversary Staff External Every 3 Years

6. Variance Notice As Occurs Staff Within 30 Days

QUARTERLY

1. Investment Worksheets Quarter End Consultant 45-60 Days After Close

2. Portfolio Operations Report Quarter End Consultant 60 Days After Close

5 “Staff” refers to ERS investment staff and “Consultant” refers to the ERS real estate consultant.



EXHIBIT 3


REAL ESTATE SEPARATE ACCOUNT

TACTICAL BUSINESS PLAN OUTLINE

PURPOSE: The Tactical Business Plan provides the manager an opportunity to articulate its capital

allocation objectives for the ensuing 12 month period relative to the Work Assignment as

outlined in each contract. Once a year the Tactical Plan is revised and all interim

manager work should comply with the business plan. Variances should be discussed with

the Investment Staff and Investment Committee. The following is the Tactical Business

Plan outline for direct investments:

II. INVESTMENT OBJECTIVES AND OPPORTUNITIES

1. Targeted Property Type (within work assignment);

2. Targeted Markets and Rationale;

3. Leasing Exposure - Occupancy and Rollover Pattern;

4. Tenant Mix Preferences;

5. Leverage; and

6. Special Opportunities.

III. SELL DISCIPLINE

1. Factors That Would Initiate a Sell; and

2. Properties Targeted For Sale and Rationale.

IV. CAPITAL DEPLOYMENT

1. Acquisition Objectives; and

2. Portfolio Repositioning.

V. PROGRAM ADMINISTRATION AND TIMING

1. Appraisals - Scheduled Internal or External;

2. Audits - Firm and Timing;

3. Insurance; and

4. Other Special Notices.



EXHIBIT 4


ANNUAL REAL ESTATE SEPARATE ACCOUNT ASSET MANAGEMENT

PLAN

PURPOSE: The Annual Asset Management Plan should be prepared for each strategic class held in the

ERS. The Investment Managers are typically reviewed in core and specialty investment

groups in early spring and late fall. Generally, the following information will be requested.

I. PROPERTY SUMMARY

Narrative discussion of the specific property, including changes to market environment, leasing

status, occupancy rate, property manager, renovation or scheduled maintenance details, and other

relevant operational issues.

II. BUDGETS

The Annual Asset Management Plan should include at least the following information and more as

the manager deems appropriate:

1. REVENUE

- Base Rent

- Overage Rents

- Recoveries

- Interest or Other Income

2. EXPENSES

Operational

- Real Estate Taxes

- Common Area Maintenance

- Insurance

- Utilities

- Ground or Other Rent

- Building Maintenance

- General & Administrative

- Property Management Fees

Non-Operating

- Capital Reserves

- Leasing Commissions

- Tenant Improvements

- Management Fees

3. DEBT SERVICE AND FINANCING

4. PROJECTED PERFORMANCE FOR SHORTER AND LONGER TIME PERIODS



TABLE OF CONTENTS

Page

1. CREDIT INVESTMENT OBJECTIVES ............................................................................................ 38

A. GENERAL DESCRIPTION ......................................................................................................... 38

B. STRATEGIC OBJECTIVE ........................................................................................................... 38

C. LONG-TERM RETURN OBJECTIVE ........................................................................................ 38

D. INVESTMENT STRATEGIES ................................................................................................... 38

E. INVESTMENT STRUCTURE ..................................................................................................... 39

2. IMPLEMENTATION .......................................................................................................................... 39

A. INVESTMENT APPROVAL PROCESS ..................................................................................... 39

B. MONITORING AND REPORTING ............................................................................................ 39

3. MANAGER GUIDELINES ................................................................................................................. 41

APPENDIX: CREDIT SUB-COMPONENT



1. Investment Objectives & Structure of the Credit Program


The Credit Program consists of investment strategies and assets that are largely exposed

and/or susceptible to various collateral types (corporate cash flows, mortgages, various

credit receivables, etc.) that produce relatively high levels of income. These investments

may be traded in public markets or sourced through private issuance. Such investments

typically contain relatively lower levels of risk and exhibit lower volatility than other Broad

Growth components but do have exposure to growth-related characteristics. In addition,

periodic income will likely be a material portion of the Credit class’s investment return.

B. Strategic Objective

The objective of the ERS Credit Program is to complement other Stabilized Growth

investments by generating a consistent return by pursuing an opportunistic non-benchmark

focused approach across global public and private credit markets.

C. Long-term Investment Return Objective

The ERS shall use the following rate of return tests to evaluate the performance of the

Credit Program sub-component portfolio:

Total Return

1. Over rolling 3-year periods, the total Credit program is expected to generate a

minimum total dollar-weighted rate of return (internal rate of return or IRR) that

exceeds an absolute return of LIBOR+6%, net of all investment management fees and

expenses.

2. Over rolling 10-year periods, the total Credit portfolio is expected to generate a

minimum time-weighted rate of return in excess of 50% Barclays Global High Yield

Index + 50% S&P LSTA Leveraged Loan Index, net of all investment management

fees and expenses.

D. Investment Strategies

The following credit strategies and investment types will be considered eligible for the

ERS’s portfolio:

1. Corporate Credit. Partnerships/Fund of Ones (“FOOs”) which invest in liquid and

less liquid corporate credit across the capital structure as well as opportunistically

provide private financing. Investment instruments and/or strategies include but are

not limited to the purchase and/or origination of investment grade, broadly

syndicated high yield bonds, broadly syndicated leveraged loans, narrowly

syndicated private debt (“club deals”), collateralized loan obligations (“CLO”)

debt and equity, municipal securities, capital solutions and convertibles.

2. Mortgage Credit. Partnerships/FOOs which invest in liquid and less liquid

mortgage credit as well as opportunistically provide private financing. Investment

instruments and/or strategies include but are not limited to the purchase and/or

origination of legacy non-agency residential mortgage-backed securities, ABS

CDOs, agency risk transfer, FNMA/Freddie preferreds, non-qualified mortgage



origination, re-performing loans, legacy CMBS, CRE CDOs, credit tenant leases

and bridge financings.

3. Specialty Finance. Partnerships/FOOs which invest in liquid and less liquid

specialty finance as well as opportunistically provide private financing.

Investment instruments and/or strategies include but are not limited to the purchase

and/or origination of marketplace lending, equipment leasing, consumer loans,

student loans, auto loan, aircraft finance and regulatory capital relief.

4. Hedging. Partnerships/FOOs which seek to opportunistically hedge beta

exposures through derivative exposures. Derivatives may be used for managing

interest rate, volatility, term structure, country, currency and sector exposures and

will be employed defensively.

E. Investment Structure

The ERS shall utilize a separate account or fund of one specifically tailored to meet the

needs of the ERS. The Credit component is expected to be allocated 100% to active

management.

2. Implementation

A. Investment Approval Process

The investment approval process (i.e., the selection of investment managers for this

component) will be consistent with ERS’s manager selection and retention processes as

discussed under Section C of this policy manual. Any selected mandates will also be

subject to the policies put forth under Section D (Broad Growth class policy) of this

manual. In addition, each manager will be subject to specific investment manager

guidelines (see Section 3 below).

B. Monitoring and Reporting

1. Reporting

Time-weighted investment performance results for Credit mandates will be reported in a

manner consistent with results produced for other account mandates under the Broad

Growth class and consistent with general reporting requirements found in Section C of this

policy manual. In addition, in order to assess whether the component is meeting its

objectives as discussed above in paragraph 1.C. (Long-term Investment Return Objective),

the General Consultant will provide an annual update of the Credit program.

In addition to the return metrics highlighted above, Investment Staff and the General

Consultant may develop additional metrics to assess the progress of the Credit program.

Such metrics may include, but not be limited to:

- Yields based upon cash income produced by the related portfolio(s);

- Default rates and/or impairment rates exhibited by the portfolio(s);

- Sector and/or collateral concentration levels within the portfolios;

- Other measures.

2. Monitoring



The Credit manager(s) will provide cash flow, valuation, and any other requested

information to Investment Staff, Consultant(s) and the ERS’s custodian bank on a monthly

basis and will notify Investment Staff of any instances of any material changes carrying

values.

Performance will be calculated on both a time-weighted and dollar-weighted (internal rate

of return or IRR) basis. The rate of return calculations will be net of all fees and expenses.

So that the performance numbers reported by the manager and the custodian are the same,

the manager will be responsible for reviewing the custodian’s figures as to timing, amount,

value of in-kind securities at distribution and reported net asset value, and reconciling and

explaining any discrepancies.



3. Manager Guidelines

Manager(s): ABC Manager




Target Return: LIBOR +6-8%

Target Volatility: <7%

Minimum Current Yield: LIBOR +4%

Key Guidelines:

- Collateral allocation maximums o Residential mortgages: 70% o Specialty finance: 70%

o Structured credit: 70%

o Corporates: 50% o Emerging Markets: 20%

o Opportunity set includes but is not be limited to: legacy non-agency RMBS, ABS CDOs, agency risk transfer, FNMA/Freddie preferreds, non-qualified mortgage

origination, re-performing loans, mortgage servicing rights, market-place lending,

aircraft leases, student loans, auto loans, CMBS, CLO debt/equity, regulatory capital relief, leveraged loans, lightly syndicated loans (“club deals”)

- Diversification o Position size maximum: 5%

o Non-U.S. domiciled issuer maximum: 50% o Emerging markets maximum: 20%

- Liquidity o Initial lock: 2 years o Private exposure not expected to exceed 50% of the market value

- Leverage o Not to exceed 1X (debt to equity)

- Hedging o Hedging ratio: 20-50%

o Derivatives may be used for managing interest rate, volatility, term structure, country, currency and sector exposures

o Derivative instruments will be limited to liquid instruments actively traded on major exchanges, or, if over-the-counter, executed with major dealers. Such

instruments may include: CMBX, ABX, HY CDX, LCDX, CDX, single name

CDS, iTraxx, ETFs and other instruments (including swaptions, puts, calls, forwards, options referencing rates, F/X, equity securities, commodities or debt) for

the purposes of hedging risk and efficiently transferring existing portfolio exposure



Manager(s): XYZ Manager




Benchmark:

- Primary: LIBOR + 4-6%

- Secondary: 50% Barclays Global High Yield Index + 50% S&P LSTA

Leveraged Loan Index* *Strategy is “benchmark aware” but is not managed relative to a benchmark

Targeted Volatility: - Not to exceed 50% Barclays Global High Yield Index + 50% S&P LSTA

Leveraged Loan Index

Minimum Current Yield L + 3%

Key Guidelines:

- Strategy allocation maximums o High yield bonds: 90% o Leveraged loans: 60%

o Investment grade bonds: 20%

o Convertibles: 10% o Structured credit: 20%

o Distressed: 25%

o Equipment leasing: 10% o Municipal debt: 15%

o Preferreds: 10%

o Cash: 20%

- Strategy allocation minimums o High yield bonds: 30%

o Leveraged loans: 10%

- Diversification o Position size maximum: 5% o Average position size: 1-2%

o Industry maximum:25%

o Non-U.S. domiciled issuer maximum: 50%

- Liquidity o Level III maximum: 25%

o 8-15 days to liquidate: 30%

- Hedging o Maximum gross exposure: 135%

o Maximum net exposure: 100%

o Minimum net exposure: 75%

o Derivatives may be used for managing interest rate, volatility, term structure, country, currency and sector exposures

o Derivative instruments will be limited to liquid instruments actively traded on

major exchanges, or, if over-the-counter, executed with major dealers. Such

instruments may include : LCDX, CDX, single name CDS, iTraxx, ETFs and other

instruments (including swaptions, puts, calls, forwards, options referencing rates, F/X, equity securities, commodities or debt) for the purposes of hedging risk and efficiently transferring existing portfolio exposure.



TABLE OF CONTENTS

Page


2. INVESTMENT OBJECTIVES ............................................................................................................ 45

A. PORTFOLIO CONSTRUCTION ................................................................................................. 45

B. TARGET ALLOCATION ............................................................................................................ 45

C. BENCHMARKING / RETURN TARGETS ................................................................................ 45

D. RISK MANAGEMENT ................................................................................................................ 46

APPENDIX

PRIVATE EQUITY SUB-COMPONENT

NON-CORE REAL ESTATE SUB-COMPONENT

APPENDIX: P R I V A T E G R O W T H C O M P O N E N T




Responsibilities

The Private Growth program shall be implemented and monitored through the coordinated efforts

of the Board of Trustees (“Board of Trustees” or “Board”) of the Employees’ Retirement System

of the State of Hawaii (“ERS”), the ERS investment staff (“Investment Staff”), the ERS general

investment consultant (“General Investment Consultant”), the ERS private equity consultant

(“Private Equity Consultant”), the ERS real estate consultant (“Real Estate Consultant”), and the

ERS specialty managers (“Specialty Managers”). Specific responsibilities that fall outside the

general responsibilities highlighted in Section B.5. are listed below:

Specific Responsibilities: Board of Trustees

Investment Selection

a. Evaluate all proposed activities or investments that may fall outside the parameters

and direction of the annual Strategic Plans;

b. Mediate any disputes regarding investment selection that may take place between

Investment Staff, the Private Equity Consultant(s) and/or Specialty Managers



2. Investment Objectives

A. Portfolio Construction

The ERS has determined that, over the long term, inclusion of private markets investments

(private equity, non-core private real estate, certain private debt opportunities, etc.) would

enhance the ERS’s expected portfolio investment characteristics. Specifically, as a result

of the possibility of enhanced rates of return over publicly traded securities and returns that

have a relatively low correlation with those associated with other major strategic classes,

the use of private equity investments tends to increase the portfolio's overall long-term

expected real return, and reduce year to year portfolio volatility.

Private growth investments of the ERS shall be made in a manner consistent with the

fiduciary standards of the prudent expert rule: (1) for the sole interest of the ERS’s

participants and their beneficiaries; and, (2) to safeguard and diversify the Private Growth

portfolio. The selection and management of Private Growth assets will be guided to

preserve investment capital and to maintain prudent diversification of assets and

management responsibility. The diversification objective is required to manage overall

market risk and the specific risks inherent in any single investment or management

selection.

B. Target Allocation

The allocation of ERS assets to Private Growth investments shall remain within the limits

authorized by the Board of Trustees. As of July 2015, the long-term target allocation of

29% of the Broad Growth class was adopted by the Board of Trustees (based on net asset

value of allocated capital). Allocated capital will be defined as invested capital (based on

market value). The Board of Trustees recognizes that it will be necessary to make capital

commitments in excess of the target allocation in order to achieve and maintain progress

toward its long-term target.

The goal of the ERS is to spread out the timing of new commitments so as to avoid an

undue concentration of commitments in any one year. Over the long-term, it is expected

that barring any unforeseen events approximately equal amounts of new funding will be

committed each fiscal year to garner the benefits of vintage year diversification.

C. Benchmarking / Return Targets


Private Growth portfolio:

Total Return (Realized and Unrealized Gain/Loss plus Income)

3. Over rolling 10-year periods, the total Private Growth portfolio is expected to generate

a minimum total dollar-weighted rate of return (internal rate of return or IRR) that

exceeds an equivalent public global equity return (MSCI ACWI IMI) by 200 basis

points (“bps”) per year, net of all investment management fees and expenses

4. Any individual fund investment is expected to produce a commensurate return that

contributes to the overall Private Growth portfolio return objectives

5. The ERS will also measure the portfolio employing a time-weighted rate of return

calculation



6. The primary investment strategies included in the allocation will provide the

opportunity for long term capital gains. The allocation will include investment

strategies that provide an element of predictable cash flow to the ERS that is not

dependent on non-recurring events such as the permanent disposition of assets

7. The portfolio and individual investments shall also be benchmarked against generally

accepted and utilized private equity or non-core real estate benchmarks (e.g., published

by Preqin, Inc., NCREIF, Venture Economics Inc., etc.).

D. Risk Management

The selection and management of assets in the Private Growth portfolio will be guided to

generate a high level of risk adjusted return, to provide a moderate amount of current

income, and to maintain prudent diversification of assets and specific investments.

With private growth investments, there is an inherent risk that the actual return of capital,

gains and income will vary from the amounts expected. The ERS shall manage the

investment risk associated with private growth investments in several ways:

1. Strategic Structure

a. Allocation by strategic component. The Private Growth component consists of

three segments: (i) private equity, (ii) non-core real estate, and (iii) other private

investments. Descriptions and characteristics of these segments are discussed in

the appendix to this section. The allowable allocation range for Private Equity is

50% to 100% of total Private Growth; and the allowable range for Non Core Real

Estate is 0% to 50% of total Private Growth.

b. Commitment pacing into each segment over time. It is expected that the private

equity component will have scheduled annual commitments that are a multiple of

the non-core real estate commitments. However, certain annual commitment

amounts among these segments may vary significantly, depending upon the capital

investment opportunities within each component.

2. Manager Selection / Institutional Quality

c. All assets must be of institutional investment quality. Institutional quality will be

defined as being of a quality whereby the investment would be considered

acceptable by other prudent institutional investors (e.g. insurance company general

accounts and separate accounts, commercial banks and savings institutions, public

employee retirement systems, corporate employee benefit plans - domestic and

foreign, and other tax-exempt institutions).

d. It shall be expected that “foundation managers” to the ERS private equity portfolio

(that is, are expected to comprise a significant subset of total ERS private growth

assets) periodically report to the Board of Trustees and/or Investment Staff on the

progress of ERS investments under their management.



TABLE OF CONTENTS

1. OBJECTIVES & STRUCTURE ........................................................................................................ 48

A. BENCHMARKING / RETURN TARGETS ................................................................................ 48

B. INVESTMENT STRUCTURES ................................................................................................... 48

C. INVESTMENT STRATEGIES .................................................................................................... 49

D. DIVERSIFICATION REQUIREMENTS .................................................................................... 49

2. IMPLEMENTATION .......................................................................................................................... 52

A. ANNUAL STRATEGIC PLAN.................................................................................................... 52

B. INVESTMENT APPROVAL PROCESS ..................................................................................... 52

C. MONITORING AND REPORTING ............................................................................................ 52

APPENDIX: PRIVATE EQUITY SUB-COMPONENT



1. Investment Objectives & Structure of the Private Equity Program

A. Benchmarking/Return Targets


Private Equity sub-component portfolio:

Total Return (Realized and Unrealized Gain/Loss plus Income)

8. Over rolling 10-year periods, the total Private Equity portfolio is expected to generate

a minimum total dollar-weighted rate of return (internal rate of return or IRR) that

exceeds an equivalent public global equity return (MSCI ACWI IMI) by 200 basis

points (“bps”) per year, net of all investment management fees and expenses

9. Any individual fund investment is expected to produce a commensurate return that

contributes to the overall Private Equity portfolio return objectives

10. The ERS will also measure the portfolio employing a time-weighted rate of return

calculation

11. The primary investment strategies included in the allocation will provide the

opportunity for long term capital gains. The allocation will include investment

strategies that provide an element of predictable cash flow to the ERS that is not

dependent on non-recurring events such as the permanent disposition of assets

The portfolio and individual investments shall also be benchmarked against generally

accepted and utilized private equity or non-core real estate benchmarks (e.g., published by

Preqin, Inc., Venture Economics Inc., etc.).

B. Investment Structures

The following are considered allowable investment structures for the private equity

program. It shall be noted that the Private Equity Consultant or Specialty Manager are

expected to act as fiduciaries on behalf of the ERS and the investment structures mentioned

below must be within accordance of the investment policies set forth in this Manual and

the annual Strategic Plan. Such investment activity is subject to active review by the Board

of Trustees and Investment Staff on a regular basis.

1. Co/Direct Investments: Co-investments may be sourced by the Private Equity

Consultant, Specialty Manager, or Investment Staff, and must be approved by the

Board of Trustees

2. Primary Investments in Private Equity Funds: Capital commitments to limited

partnerships and/or limited liability companies established for the purpose of private

equity investment are managed through the Private Equity Consultant or a Specialty

Manager

3. Secondary Investments: Purchasing an existing interest in a private equity fund

(generally at a discount) is managed through the Private Equity Consultant or a

Specialty Manager

4. Separate Accounts: investment vehicles typically set up for a single limited partner

where the investment manager constructs a diversified portfolio of private market

investments that are tailored specifically to the needs and objectives of the investor.

Separate accounts should offer the ERS access to economics that are below generally

prevailing rates and/or target strategies that are traditionally difficult for the ERS to

access directly (e.g., Venture Capital)



C. Investment Strategies

The following private equity strategies and investment types will be considered eligible for

the ERS’s portfolio:

5. Corporate Finance/Buyout: Partnerships/LLCs which provide funding to acquire

majority or controlling interests in a business or product lines from either a public

or private company. Buyout sub-strategies are classified by total capital

commitments and include Small, Mid, Large and Mega buyouts

6. Fund-of-Funds: Blind pool partnerships/LLCs that evaluate, select and monitor

investments in other limited partnership/LLC investments

7. Mezzanine Debt: Partnerships/LLCs which invest in unsecured or junior

obligations in financings. These generally take the form of subordinated

debentures or preferred stock. They typically earn a current coupon or dividend

and have warrants on common stock or conversion features

8. Distressed Debt: Partnerships/LLCs which invest in non-investment grade

privately placed debt securities. Common sub-strategies include Distressed For

Control, Non-Control and Trading

9. Project Finance: Partnerships/LLCs which invest in industrial leveraged or

unleveraged lease or project financings. These can include participation in equity,

mezzanine, or senior debt investments. Investments should be made after the

development phase, as part of the project's permanent financing, when projects are

going operational

10. Special Situations: Partnerships/LLCs with investment strategies which have

gained an institutional following, but where sporadic opportunities do not justify a

separate long-term strategic allocation. Categories includes partnerships/LLCs

which make strategic block investments, have very broad mandates, focus on

restructuring/recovery or focus on specific industries or which seek to exploit

opportunities created by changing industry trends or governmental regulations

11. Venture Capital: Investments in start-up companies generally exhibiting promising

potential and/or high-growth characteristics. Such investments generally exhibit

minimal leverage and can consist of the following stages: Seed/Early, Middle,

Late-Stage and Growth Equity

12. Other: Partnerships/LLCs which invest in publicly-traded securities or which

employ strategies different from those cited above such as, hedge fund strategies,

commodity trading, post-venture equities, investments in commercial leases, and

other non-traditional strategies. The purchase of secondary partnership/LLC

interests is also allowed

D. Diversification Requirements

The private equity portfolio shall be diversified as to investment strategy, timing of

investment, size and life cycle of investment, industry sector, investment sponsor

organization (e.g., general partner group), capital structure and geographical location.

Diversification reduces the impact on the portfolio of any one investment or any single

investment style to the extent that an adversity affecting any one particular area will not

impact a disproportionate share of the total portfolio.

These limits are subject to waiver on a case-by-case basis by the Board of Trustees. It is

also recognized that during the portfolio development and wind-down stages the full

investment parameters may not, of necessity, be met.



The scope and size of the ERS program is such that significant investments in fewer, more

concentrated “foundation” managers are preferred to smaller, more numerous managers.

While ERS has not set a minimum dollar amount per partnership/LLC, the Private Equity

Consultant and/or Specialty Manager will be charged with deploying the capital efficiently,

such that funding targets are achieved with a minimal number of partnership/LLC holdings.

Long-term diversification targets among eligible investment strategies will be set forth in

the annual Strategic Plan document, and reviewed and updated as necessary.

1. Geographic

Over the long-term, the ERS portfolio should seek portfolio diversification with regard

to major regional areas both domestically (e.g., Northeast, Mid-Atlantic, Southeast,

Midwest/Plains, Southwest/Rockies, West Coast, Pacific Northwest), and

internationally (e.g., Europe, Asia Pacific, South and Latin America, Middle East and

Africa).

The portfolio shall primarily target investments domiciled within North America. In

line with the ERS’s total international allocation, the portfolio shall seek to limit

international investments (outside of North America) by targeting no more than 35%

of the private equity investment allocation to such investments. The currency exposure

to the ERS from the non-dollar aspect of the allocation is expected to be negligible.

2. Industry

The ERS portfolio will seek to diversify by industry sector (as outlined through the

Global Industry Classification Standard) and shall target that no one industry

classification represent more than 35% of the private equity portfolio.

3. Life Cycle

Commitments to partnership/LLC investments generally will be staged over time. It

is the long-term goal of ERS to spread out investment timing such that new

commitments will be made each fiscal year. This policy will have the effect of dollar

cost averaging the ERS’s portfolio over business cycles to help insulate the portfolio

from event risk.

4. Strategic

The private equity portfolio shall target that no single private equity investment sub-

strategy (as highlighted in Section II(f) above) comprise more than 50% of the total

allocation.

5. General Partner

The ERS portfolio will seek to diversify by issuer of limited partnership/LLC

securities, and other specific investments sponsors. No more than 20% of the ERS’s

private equity portfolio net asset value will be invested with any one investment

sponsor organization.

It is the intention of ERS to keep the total holdings of the portfolio to a reasonable

number. Given the significant total dollar size of the ERS’s private equity net asset



value target, large concentrated investments in fewer partnerships/LLCs, are preferred

to smaller investments across numerous partnership/LLC securities.

6. Single Investment

No single private equity commitment shall comprise more than 100bps of total ERS

assets under management or greater than 20% of targeted annual commitment pace per

the annual Strategic Plan. An exception to this limitation may be offered for separate

accounts, subject to approval by the Board of Trustees.

7. Limited Partner

The ERS is permitted to own up to 20% of any particular partnership/LLC subject to

the General Partner limitation (item v) above.



2. Implementation of Private Equity Program

A. Annual Strategic Plan

1. Annually, the Private Equity Consultant and Specialty Managers (if applicable), in

conjunction with Investment Staff, will prepare a Strategic Plan which reviews the

current status of the portfolio, recent historical and prospective market conditions, and

proposes the actions to be taken over the next approximately twelve month period. This

document will recommend general capital allocations to each investment strategy and

the rationale and expectations for inclusion

2. The annual Strategic Plan will then be presented to the Board of Trustees for approval

B. Investment Approval Process

The following steps shall be followed in order for the ERS to commit to any prospective

private equity investment opportunity:

1. Private Equity Consultant sources and performs comprehensive due diligence on

attractive investment opportunities consistent with criteria set forth in the annual

Strategic Plan

2. If, as a fiduciary of the ERS, the Private Equity Consultant determines that the

investment merits a commitment from the ERS, the Private Equity Consultant will take

the following steps:

Discuss with Investment Staff the key findings during due diligence, including

investment merits, risks and key conclusions

Follow-up with Investment Staff on additional requests for information based

on this discussion and complete an Investment Disclosure Form

In conjunction with the ERS’s legal review process, facilitate legal negotiation

and closing into the investment opportunity

3. The Board of Trustees shall be notified in the event of a disagreement between

Investment Staff and the Private Equity Consultant on an investment recommendation

4. The Specialty Manager (if applicable) will be expected to operate on a discretionary

basis

The Specialty Manager is to operate under the oversight of and provide regular

updates to the Board of Trustees, Staff and the Private Equity Consultant

C. Monitoring and Reporting

1. Reporting System

There shall be a quarterly reporting and monitoring system for the entire portfolio by

the Private Equity Consultant. The monitoring shall include asset/risk allocation and

portfolio performance in sufficient detail to identify situations of underperformance,

diversification deficiencies and conflicts of interest. Due to the large number of funds,

the ERS investment staff will employ a sampling methodology to verify that the Private

Equity Consultant is adequately executing the monitoring program and detecting major

performance issues within the private equity portfolio.

2. Performance Measurement

The Private Equity Consultant and Specialty Manager(s) will provide cash flow,

valuation, and any other requested information to Investment Staff and the Private



Equity Consultant quarterly, and the ERS’s custodian bank (“custodian”) on a monthly

basis, and will notify Investment Staff of any instances of materially different carrying

values from those reported by general partners.

Performance will be calculated on both a time-weighted and dollar-weighted (internal

rate of return or IRR) basis, with primary emphasis being placed on the internal rate of

return. The rate of return calculations will be net of all partnership/LLC fees and

expenses, but gross of Private Equity Consultant and/or Specialty Manager fees and

expenses. So that the performance numbers reported by the manager and the custodian

are the same, the manager will be responsible for reviewing the custodian’s figures as

to timing, amount, value of in-kind securities at distribution and reported net asset

value, and reconciling and explaining any discrepancies.

Investment Staff and/or the appropriate designated retained Private Equity Consultant

will provide performance measurement information, if requested by the Board, on all

other private markets investments outside of the authority of the Private Equity

Consultant or Specialty Manager(s).

In-kind Distributions: Partnerships/LLCs will be valued on the distribution price of

the in-kind security or other valuation method stipulated in the partnership/LLC

membership agreement. Any change from distribution price to realized price of the in-

kind distributions will then be monitored as a separate component of the total portfolio

return.

Benchmarks: For IRR calculations, the Vintage Year methodology developed by

Preqin, inc. and/or Venture Economics, Inc. will be used for purposes of performance

comparisons to the industry. For time-weighted returns, comparable publicly traded

market indicators (such as small cap indices) will be employed.



TABLE OF CONTENTS

Page

1. REAL ESTATE INVESTMENT OBJECTIVES ................................................................................ 55

A. INVESTMENTS IN REAL ESTATE .......................................................................................... 55

B. NON CORE STRATEGIC ALLOCATION ................................................................................ 55

C. NON CORE PORTFOLIO RETURN OBJECTIVES ................................................................. 55


A. OVERVIEW .................................................................................................................................. 56

B. PARTICIPANT ROLES AND RESPONSIBILTIES .................................................................. 56

C. ANNUAL STRATEGIC PLAN.................................................................................................... 56

D. NON CORE PORTFOLIO COMPOSITION ............................................................................... 57

E. INVESTMENT AND RISK MANAGEMENT ........................................................................... 59

3. REAL ESTATE INVESTMENT PROCESS ...................................................................................... 60

4. CONTROL AND MONITORING SYSTEMS ................................................................................... 60

APPENDIX: NON-CORE REAL ESTATE SUB-COMPONENT



1. Non Core Real Estate Investment Objectives

A. Investments In Real Estate

The Employees’ Retirement System of the State of Hawaii (“ERS”) completed a strategic

allocation study for the investment of its assets. This analysis demonstrated that, over the

long term, inclusion of investments in private equity real estate and debt positions in real

estate properties would enhance the ERS’s expected portfolio investment characteristics

while reducing expected total portfolio volatility.

In general, the ERS desires to obtain the optimum return on the portfolio consistent with

the assumption of prudent risk. While safety of principal is given primary consideration,

the ERS recognizes the need to use active asset management strategies in order to obtain

the highest attainable total investment return (income plus appreciation) within the ERS’s

framework of prudence and managed risk.

Non core real estate investments of ERS shall be made in a manner consistent with the

fiduciary standards of the prudent person rule: (1) to safeguard and diversify the non core

real estate portfolio; and, (2) for the sole interest of the participants and their beneficiaries.

The selection of investment managers and development of investment policy will be guided

to enhance diversification within the portfolio of the ERS’s non core real estate investment

program (“Non Core Real Estate Investment Program”) thereby limiting exposure to any

one investment, organization, real estate property type and geographic region (Refer to

Section II: Program Management).

1. Real Estate Defined - Real estate assets are defined as those investments that are

unleveraged or leveraged, private equity or debt positions in real property. The

ownership structure(s) should be consistent with any rules, regulations, or law, as

applicable, governing the ERS. For the Non Core Real Estate Program, the ERS will

utilize discretionary commingled fund investments.

B. Non Core Real Estate Strategic Allocation

Noncore real estate allocations will be established and managed via scheduled annual

commitment pacing approved as a result of the annual strategic plan (see item 2.C. below).

As a segment of the larger Private Growth component, commitment pacing will be

influenced by Non Core Real Estate’s potential to contribute long-term risk-adjusted

returns relative to that of Private Equity, the other (and larger) component of Private

Growth. Non Core Real Estate is not allowed to exceed 50% of the Private Growth

component, based on the market value of current investments.

C. Portfolio Return Objectives

The noncore real estate return objectives will follow their respective assignments as

detailed in Broad Growth Section D.3. Return Objectives & Risk Profile.



2. Non Core Real Estate Program Management

A. Overview

In compliance with current ERS investment philosophy, the Non Core Real Estate

Investment Program will primarily utilize discretionary commingled fund investment

vehicles that are sponsored by real estate investment managers (“Investment Managers”).

Under this program, the Investment Managers acquire, operate and dispose of real estate

assets in accordance with the fund documents for specified commingled funds. These

documents typically describe the acceptable property types, geographic restrictions,

investment structures, leverage and other specific investment parameters. Commingled

fund documents typically refer to the fund’s offering memorandum or private placement

memorandum, limited partnership or LLC membership agreement, and subscription

agreement. The commingled funds’ activities will be reviewed annually by Investment

Staff, Real Estate Consultant, and the Board of Trustees (Refer to Section IV)

B. Participant Roles and Responsibilities

The ERS’s Non Core Real Estate Investment Program shall be implemented and monitored

through the coordinated efforts of the Board of Trustees; through the Investment Staff; the

ERS’s general investment consultant (“General Investment Consultant”); the ERS’s real

estate consultant (“Real Estate Consultant”); and the Investment Manager(s). Specific

responsibilities are listed below:

Investment Manager - Qualified real estate organizations, registered as Investment

Advisors under the 1940 Act that provide institutional real estate investment

management services to the ERS. ERS may invest in commingled fund vehicles that

are not registered, however, it is preferred that the commingled fund be sponsored

and/or managed by a Registered Investment Advisor.

Commingled Fund Manager Responsibilities – The commingled fund Investment

Manager, acting as a fiduciary on behalf of ERS, acquires, manages and disposes of

real estate properties and/or originates or acquires, manages, and realizes upon real

estate debt investments in accordance with the terms of the investment vehicle

documents.

C. Annual Strategic Plan

1. Annually, the Real Estate Consultant, in conjunction with Investment Staff, will prepare

a Strategic Plan which reviews the current status of the portfolio, recent historical and

prospective market conditions, and proposes the actions to be taken over the next

approximately twelve-month period. This document will recommend general capital

allocations to the Non Core Real Estate Program and the rationale and expectations for

inclusion. 2. The annual Strategic Plan will then be presented to the Board of Trustees for approval and

will typically take place in conjunction with the presentation of the Core Real Estate

Strategic Plan.



D. Non Core Real Estate Portfolio Composition

Non core real estate investments represent equity or debt investments in those properties

and/or investment strategies that require specialized acquisition and management expertise

or skill to mitigate the business and leasing risk that may be associated with individual

investments. Non core investments which may be referred to as Value Added or

Opportunistic have greater volatility compared to core investments and as such are

expected to provide yields higher than those associated with core investments.

Value Added – Value added investments include equity or debt investments in

institutional quality assets that offer the opportunity to enhance value through

rehabilitation, redevelopment, development, lease-up or repositioning. A significant

portion of return is from appreciation and includes moderately higher leverage than

core. Value added investments typically exhibit one or more of the following

characteristics:

Properties located in primary as well as secondary and tertiary markets

which may not be economically diversified and may have accompanying

susceptibility to imbalance of demand and supply;

Traditional as well as non-traditional property types including hotels,

motels, senior housing, student housing, manufactured and residential

housing;

Properties that are undermanaged with specific problems that require

specialized management skills;

Properties that are less than 70% leased upon purchase or where more than

30% of leases expire in the first three years of purchase

Properties which are considered to be in a “work out” mode;

Properties involving significant appreciation, lease-up, development

and/or redevelopment risks;

Properties using moderate leverage between 50% and 65%;

Investments in institutional quality properties located in mature real estate

markets showing high levels of market transparency outside of the United

States and Canada;

Total gross return expectations are between 11% and 13%

Opportunistic – Opportunistic investments include equity or debt investments in real

estate properties, real estate operating companies and other investment vehicles that

offer the opportunity to capitalize on the disequilibrium of the real estate markets

caused by dramatic shifts in capital flows or other fundamental real estate

characteristics. Opportunistic investments not only include distressed assets in need

of lease up but also assets that provide returns from financial restructuring.

Opportunistic investments typically exhibit one or more of the following

characteristics:

Strategies that seek to exploit inefficiencies in the capital and real estate

markets

Strategies that involve financing or acquisition of real estate assets,

operating companies, portfolio of real estate assets

Properties with substantial leasing, development and entitlement risk

Distressed assets

Distressed debt



Major financial re-structuring required

High leverage of between 65% and 75%

Investments in emerging real estate markets driven by growth and

continued improvements in market transparency, located outside of the

United States and Canada

Total gross return expectations are in excess of 15%



E. Investments and Risk Management

The ERS shall manage the investment risk associated with non core real estate in several

ways:

1. Institutional Quality - All assets within the Non Core portfolio must be of

institutional investment quality as evidenced by a history of institutional

investment in similar properties; expert analysis which supports the economic

viability of the market; high quality construction and design features; and a

current or potentially competitive position within the property’s immediate

market area.

2. Ownership Structure - The ownership structure for Non Core investments

includes leveraged and unleveraged equity and debt investments owned indirectly

by ERS on a pro rata basis through institutional-quality commingled funds. The

ownership structure of non core assets within commingled funds will be governed

by the fund documents. When dealing with non core investments that are directly

owned, Operating Partners shall be added to the list of “Suitable Investment

Partners.”

3. Leverage – Within the Non Core segment, it is expected that significant amounts

of leverage may be utilized in order to enhance yields of the various investments

and/or facilitate diversification of a specific commingled fund. In aggregate, the

ERS Non Core portfolio of commingled funds will have a maximum debt limit of

75% of aggregated assets. Depending on the strategies of specific commingled

funds, the debt level of a specific commingled fund may exceed the 75% level.

5. Manager Concentration – ERS shall limit its exposure to any single manager.

No single Investment Manager shall be permitted to manage more than 35% of the

total allocation to Non Core real estate at the time of investment (based upon total

committed capital).

6. Investment Size – The ERS’s investments in a single commingled fund shall not

exceed 20% of the total net market value of the commingled fund at the time of

investment. If the commingled fund is in the process raising assets (versus being

an open-ended fund), the 20% threshold will be based on target fund size.



3. Non Core Real Estate Investment Process


non core real estate investment opportunity:

1. Real Estate Consultant sources and performs comprehensive due diligence on

attractive investment opportunities consistent with criteria set forth in the annual

Strategic Plan.

2. If, as a fiduciary of the ERS, the Real Estate Consultant determines that the investment

merits a commitment from the ERS, the Real Estate Consultant will take the following

steps:


investment merits, risks and key conclusions;


on this discussion and complete an Investment Disclosure Form;


and closing into the investment opportunity.

3. Upon successful review of the investment by the Real Estate Consultant and

Investment Staff, the investment shall be recommended to the Board of Trustees for

approval. This recommendation shall contain a summary of the due diligence and a

prospective commitment level for the investment.

4. The Investment Manager of the recommended commingled fund will be expected to

operate on a discretionary basis.

The Investment Manager of each commingled fund is to operate under the

oversight of and provide regular updates to the Board of Trustees, Staff and

the Real Estate Consultant.

4. Monitoring and Reporting

1. Reporting System

There shall be a comprehensive reporting and monitoring system for the entire

portfolio, Real Estate Consultant, Investment Manager(s) of commingled funds, and

individual investments. Situations of underperforming investments, portfolio

diversification deficiencies from the Policies & Procedures, and conflicts of interest

can then be identified, facilitating active portfolio management.


The Real Estate Consultant and Investment Manager(s) will provide cash flow,

valuation, and any other requested information to Investment Staff and the Real Estate

Consultant quarterly, and the ERS’s custodian bank (“custodian”) on a monthly basis,

and will notify Investment Staff of any instances of materially different carrying values

from those reported by Investment Manager(s)/general partner(s).

Performance will be calculated on both a time-weighted and dollar-weighted (internal

rate of return or IRR) basis, with primary emphasis being placed on the internal rate of

return. The rate of return calculations will be net of all fund/partnership/LLC fees and

expenses, but gross of Real Estate Consultant fees and expenses. So that the

performance numbers reported by the manager and the custodian are the same, the



Investment Manager(s) will be responsible for reviewing the custodian’s figures as to

timing, amount, value of in-kind securities at distribution and reported net asset value,

and reconciling and explaining any discrepancies.

Benchmarks: For IRR calculations, a Vintage Year methodology will be used for

purposes of performance comparisons to the industry. For time-weighted returns,

comparable publicly traded market indicators may be employed.


SECTION E

P R I N C I P A L P R O T E C T I O N P R O G R A M

S E C T I O N: E


SECTION E

TABLE OF CONTENTS

Page

1. OVERVIEW ........................................................................................................................................... 1


B. PURPOSE ........................................................................................................................................ 1


2. CLASS STRUCTURE ........................................................................................................................... 2

A. MODIFICATIONS TO CLASS STRUCTURE ............................................................................. 2

B. MANAGEMENT OF CLASS ........................................................................................................ 2

C. MANAGERS’ ALLOCATIONS .................................................................................................... 2

3. RETURN & RISK OBJECTIVES ......................................................................................................... 4

A. CLASS RETURN BENCHMARK ................................................................................................. 4


4. MANAGER INVESTMENT GUIDELINES ........................................................................................ 5

A. PRINCIPAL PROTECTION MANAGERS................................................................................... 5

APPENDIX




SECTION E PAGE | 1

E.1. Overview


The Principal Protection class consists of investment strategies and assets that are largely

exposed and/or susceptible to changes in interest rates and/or inflation, while only

minimally exposed to the equity risk premium. Such investments typically contain

relatively low levels of risk and exhibit lower volatility than other strategic classes.

Investments within the Principal Protection class are expected to produce relatively low

levels of returns commensurate with their relatively lower risk profile. In addition, periodic

income will likely be a material portion of the Principal Protection class’s investment

return.

B. Purpose

The Principal Protection class is expected to perform two functions. First, the Principal

Protection class is expected to provide consistent, stable returns during all phases of an

investment cycle. Second, the Principal Protection class is expected to preserve principal

during periods when investments in the Broad Growth class are experiencing significant

drawdowns/reductions in value. There may be instances when the correlation between

Principal Protection investments and Broad Growth investments are positive (e.g., during

a period of rapid rises in interest rates), but such periods should be relatively rare. Over

long investment horizons (i.e., greater than 10 years), the Principal Protection class is

expected to maintain its purchasing power, producing nominal returns that are near, or

slightly exceed, the rate of inflation.

An objective of the Principal Protection class is to capture a spectrum of risk premiums/risk

factors that are unrelated to and/or offset the behavior of the equity risk premium.


Major


Minor

- Inflation Risk

- Liquidity Risk


SECTION E PAGE | 2

E.2. Class Structure

A. Modifications to Component Structure

Currently, the Principal Protection class is a single-component class. Modifications to the

Principal Protection class’s structure can take four forms:

v. Adding or deleting a specific component;

vi. Adding or deleting a specific investment strategy within a specific component;

vii. Establishing strategy allocation levels and ranges;

viii. Establishing allocation levels and ranges among the components (if needed).

Modifications to the Principal Protection class’s structure will occur only with approval of


B. Management of Class

To manage the assets assigned to the Principal Protection class, the Board of Trustees

(“Board of Trustees’ or “Board”) of the Employees’ Retirement System of the State of

Hawaii (“ERS”) utilizes active management. Per policy, the Board delegates the manager

selection process to the ERS’s general investment consultant (“General Investment

Consultant”) and ERS investment staff (“Investment Staff”), but retains final decision

authority for selecting managers for a specific investment mandate.

Within the class, assets are allocated across a series of mandates and/or investment styles.

In combination, these mandates and styles capture a broad, representative sampling of the

available investment opportunity set within the class. The mandate/style allocations for

the Principal Protection class are as follows:

Principal Protection Allocation Policy

Principal Protection – 100%

U.S. Intermediate Fixed –

55%

Global Intermediate Fixed –

45%

Within U.S. Intermediate Fixed Within Global Intermediate Fixed

Passive 0% Passive

Active

0%

Active 100% 100%

Investment Staff is responsible for reporting to the Board strategy/style allocation levels

that vary materially from their allocation targets.

C. Class Managers and Managers’ Allocations

To manage the assets allocated to each strategic class, the Board delegates investment

authority to external investment managers (“investment managers”). The ERS’s general

investment consultant and Investment Staff have joint authority for identifying and

selecting investment manager candidates for specific investment mandates. The Board has

final authority over the selection of specific managers for each mandate. Investment Staff

has the authority to manage the allocation to each investment manager. Under this

authority, Investment Staff may reduce funding to one or more specific manager(s) and/or

increase funding to one or more specific manager(s) as long as the risk profile of the


SECTION E PAGE | 3

Principal Protection class is maintained. The manager allocations within the Principal

Protection class are as follows:

Principal Protection Class Manager Allocation Policy

Principal Protection – 100%

U.S. Intermediate Fixed –

55%

Global Intermediate Fixed –

45%

Within U.S. Intermediate Fixed Within Global Intermediate Fixed

Active – First Hawaiian 50% Active – Eaton Vance

100%

Active – Bank of Hawaii 50%

Staff is responsible for reporting to the Board manager allocation levels that vary

materially from their allocation targets.


SECTION E PAGE | 4

E.3. Return Objectives & Risk Profile


The ERS utilizes the target benchmark below to monitor the performance results of the

Principal Protection class:

45% Bloomberg Barclays Capital Global Intermediate Aggregate ex-Credit Index (Hedged)

55% Bloomberg Barclays Capital U.S. Intermediate Aggregate ex-Credit Index

The Principal Protection class portfolio is expected to outperform the above blended

benchmark, net of fees, over a full investment cycle. An appropriate measure of an

investment cycle would be rolling 5-year periods. The Principal Protection class portfolio

should outperform its benchmark, net of fees, over the majority of rolling 5-year periods.


In aggregate, the Principal Protection class is the ERS’s most stable investment class and

is the class that should be the least sensitive to varying economic growth trends. Based on

current capital market assumptions and the Principal Protection class’s long-term structure,

there is an extremely low probability that this class will lose any of its capital within the

next five years. This absence of potential volatility is meant to complement the high

volatility associated with the Broad Growth class. The key tradeoff is that the long-term

expected return of the Principal Protection class is significantly lower than that of the Broad

Growth class.

The ERS is expected to manage the Principal Protection class portfolios by taking active

risk (tracking error) around the respective benchmarks discussed under Section E.3.A.

above. Active risk within the broader class is the aggregation of several risks

taken/accepted by Investment Staff and/or ERS’s external investment managers as they

implement the class’s portfolios. Types of active risk include: security selection risk,

sector/style bias risk, manager weighting risk, and benchmark misfit risk. The allowable

active risk range for the aggregate Principal Protection class is 1.0% - 3.0%/year.


SECTION E PAGE | 5

E.4. Manager Investment Guidelines


Statutes, the Derivatives Policy and Watch Criteria in the Appendix of this section, and the following

guidelines:

A. Principal Protection Class

US Intermediate Fixed Income

Manager(s): First Hawaiian Bank

Bank of Hawaii



Class: Principal Protection

Benchmark: BB U.S. Intermediate Aggregate ex-Credit





- Securities rated by all three agencies are assigned the middle rating o For example, for a security to be rated A it must be rated at least A by two of the

three agencies

- Securities rated by only two agencies are assigned the most conservative

rating

- Securities rated by only one agency are assigned that rating

- Minimum issuance size is $100 million Excludes Agency MBS

- Specific security-type limits:

o Summary concentration comments:

Concentration limits should be determined exclusive of explicit currency and/or

currency derivative positions. Sector, rating, and other allocations shall be

compared to equivalent allocation levels of the appropriate unhedged benchmark. For example, if a manager holds a 5% position of debt issued in South Africa, holds

a (2%) short position in the Rand, and the unhedged benchmark weighting of South

Africa is 1%, then the 5% unhedged position counts against Emerging Markets limitation and the manager is 4% overweighted in South Africa. Separately, a 3%

currency exposure (5% less 2%) counts against the absolute currency exposure

constraint.

o Individual issuers shall not exceed 5% of the portfolio value at time of purchase

Excludes Government Supported securities. Specific mortgage pools and trusts are

considered separate issuers, and each tranche within a CMO is considered a separate issue.

Government Supported = Supranationals, U.S. Treasuries, sovereign debt of

OECD governments, U.S. agencies and government sponsored enterprises,

and equivalently-rated agencies of OECD governments.

o CMOs and asset-backed securities: minimum of AAA rating

o Preferred stock and converted common stock: no more than 10% of portfolio;

converted stock not held more than 180 days

o Non-U.S. Dollar Denominated Max. 10%

o Emerging Markets (all currencies) Max. 10%


SECTION E PAGE | 6

Manager uses the World Bank’s definition for emerging markets,

which is based on a GNP per capita calculation.

o Private Placements Max. 10% Excludes 144A

o Convertible Securities Max. 0%

o Non-U.S. Agency CMO Max. 10%

- Quality: o Non-Investment Grade / Unrated = 0%

- Non-Benchmark Markets (ex cash): o Non-Benchmark = 0-20%

Benchmark markets are based on currency denomination and security type.

- Foreign Currency: o Max. Net* = 10%

o Max. Gross* = 20%





*Net foreign currency exposure is the amount of offsetting currency exposure versus a portfolio’s or benchmark’s cash market security positions. For example, a

local-market sector amounting to a 5% portfolio weighting offset by a (5%) short position in the commensurate local currency would result in a zero net foreign

currency exposure. Net foreign currency exposure will be measured as the absolute value of all country-level net currency positions (long and short) versus the U.S.

Dollar. Both long and short foreign currency positions may be held without owning securities denominated in such currencies.

Gross foreign currency exposure will be measured as the absolute value of all country-level currency positions (long and short) versus the U.S. Dollar. Both long

and short foreign currency positions may be held without owning securities denominated in such currencies.

Global Intermediate Fixed Income

Manager(s): Eaton Vance



Class: Principal Protection

Benchmark: BB Global Intermediate Aggregate ex. Credit Index (hedged)





- Issuers rated by all three agencies are assigned the middle rating o For example, for a security to be rated A it must be rated at least A by two of the

three agencies

- Issuers rated by only two agencies are assigned the most conservative

rating

- Issuers rated by only one agency are assigned that rating

- Minimum issuance size is $100 million

- Specific security-type limits:

o Summary concentration comments:

Concentration limits should be determined exclusive of explicit currency and/or currency derivative positions. Sector, rating, and other allocations shall be

compared to equivalent allocation levels of the appropriate unhedged benchmark.


SECTION E PAGE | 7

For example, if a manager holds a 5% position of debt issued in South Africa, holds

a (2%) short position in the Rand, and the unhedged benchmark weighting of South

Africa is 1%, then the 5% unhedged position counts against Emerging Markets

limitation and the manager is 4% overweighted in South Africa. Separately, a 3% currency exposure (5% less 2%) counts against the absolute currency exposure

constraint.

o Individual issuers shall not exceed 5% of the portfolio value at time of purchase

Excludes Government Supported securities. Specific mortgage pools and trusts are

considered separate issuers, and each tranche within a CMO is considered a

separate issue. Government Supported = Supranationals, U.S. Treasuries, AAA rated

sovereign debt, sovereign debt of OECD governments, U.S. agencies and

government sponsored enterprises, and equivalently-rated agencies of OECD

governments.

o CMOs and asset-backed securities: minimum of AAA rating

o Preferred stock and converted common stock: no more than 10% of portfolio;

converted stock not held more than 180 days

o Emerging Markets (all currencies) Max. 20%

Manager uses the World Bank’s definition for emerging markets,

which is based on a GNP per capita calculation.

o Private Placements Max. 10%

Excludes 144a

o Convertible Securities Max. 0%

o Non-U.S. Agency CMO Max. 10%

- Quality: o Non-Investment Grade / Unrated = 0%

- Non-Benchmark Markets (ex cash): o Non-Benchmark = 0-40% Benchmark markets are based on currency denomination and security type.

- Foreign Currency: o Max. Net* = 100% o Max. Gross* = 100%





*Net foreign currency exposure is the amount of offsetting currency exposure versus a portfolio’s or benchmark’s cash market security positions. For example, a

local-market sector amounting to a 5% portfolio weighting offset by a (5%) short position in the commensurate local currency would result in a zero net foreign

currency exposure. Net foreign currency exposure will be measured as the absolute value of all country-level net currency positions (long and short) versus the U.S.

Dollar. Both long and short foreign currency positions may be held without owning securities denominated in such currencies.

Gross foreign currency exposure will be measured as the absolute value of all country-level currency positions (long and short) versus the U.S. Dollar. Both long

and short foreign currency positions may be held without owning securities denominated in such currencies.


SECTION E PAGE | 8

P R I N C I P A L P R O T E C T I O N : A P P E N D I X


SECTION E PAGE | 9

Derivatives Policy

Derivatives may be used in the ERS portfolio as a substitute for a cash market security, risk control, income, cost

reduction, or liquidity management. Derivatives are not permitted for purposes of speculation. Any derivative

investment not explicitly authorized below is prohibited.




The notional value of the options may not exceed the total value of the underlying securities.



Futures –bond futures, money market futures, and currency futures where the manager has the

authority to invest in the underlying or deliverable cash market security.

Options – options on indices, ETFs, and bonds (including interest rate caps and floors). Options

on futures, swaps, and currencies are allowed for those managers who have permission to invest

in the underlying or deliverable cash market security.


market instrument.

Swaps – where the manager has the authority to invest in the underlying cash market instrument.

Minimum counterparty rating: A-


traded.


noted.




Cross-hedging is permitted for managers who are measured against a benchmark that contains non-USD

securities. Additionally, these managers may also use certain developed-market currencies as proxies for

otherwise illiquid emerging-market currencies. In such cases, use of such proxies will be disclosed

through the ongoing reporting process. The counterparties for foreign currency derivatives must be rated

A- or equivalent.










SECTION E PAGE | 10

0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00%

Watch Threshold -0.41% -0.82% -1.23% -1.63% -2.04% -2.45% -2.86% -3.27% -3.68% -4.08%


Watch Threshol -0.17% -0.33% -0.50% -0.67% -0.85% -1.02% -1.20% -1.38% -1.55% -1.73%


Watch Threshold 0.995 0.991 0.986 0.981 0.976 0.971 0.966 0.961 0.956 0.951


5.50% 6.00% 6.50% 7.00% 7.50% 8.00% 8.50% 9.00% 9.50% 10.00%

Watch Threshold -4.49% -4.90% -5.31% -5.72% -6.13% -6.53% -6.94% -7.35% -7.76% -8.17%


Watch Threshol -1.92% -2.10% -2.29% -2.47% -2.66% -2.85% -3.04% -3.24% -3.43% -3.63%


Watch Threshold 0.946 0.940 0.935 0.929 0.924 0.918 0.912 0.907 0.901 0.895


Long-Term

(5-year)

Short-Term

(1-year)

Medium-Term

(3-year)

Long-Term

(5-year)

Tracking Error

Tracking Error

Short-Term

(1-year)

Medium-Term

(3-year)

Watch Criteria and Implied Excess Returns (annualized)

Short-Term Criteria:


Medium-Term Criteria:


Long-Term Criteria:


VRR = manager cumulative return / benchmark cumulative return


Rationale:














SECTION F

R E A L R E T U R N P R O G R A M

S E C T I O N: F


SECTION F

TABLE OF CONTENTS

Page

1. OVERVIEW ........................................................................................................................................... 1


B. PURPOSE ........................................................................................................................................ 1


2. CLASS STRUCTURE ........................................................................................................................... 2

A. COMPONENTS .............................................................................................................................. 2

B. MODIFICATIONS TO COMPONENT STRUCTURE ................................................................ 2

C. COMPONENTS’ ALLOCATIONS AND ALLOCATION RANGES ......................................... 3

D. MANAGEMENT OF COMPONENTS ......................................................................................... 3

E. COMPONENTS’ MANAGERS & MANAGERS’ ALLOCATIONS .......................................... 4




C. COMPONENT RISK PROFILE(S) ................................................................................................ 6


A. PUBLIC INFLATION-LINKED COMPONENT MANAGERS .................................................. 7

APPENDIX



TIMBER SUB-COMPONENT ..................................................................................................... 12

INFRASTRUCTURE SUB-COMPONENT ................................................................................ 24

AGRICULTURE SUB-COMPONENT ....................................................................................... 28


SECTION F PAGE | 1

F.1. Overview


The Real Return class is expected to invest in investment strategies and assets that are

largely exposed to changes in inflation and/or interest rates, while only minimally exposed

to the equity risk premium. Such investments contain various levels of risk and typically

exhibit modestly more volatility than the Principal Protection class, but less volatility than

the Broad Growth class. The Real Return class consists of two major components: Public

Inflation-Linked and Private Inflation-Linked. The Public Inflation-Linked component

consists of investment strategies that rely on the public markets to gain exposure to

inflation-oriented assets. The Private Inflation-Linked component consists of investment

strategies that rely on the private markets to gain exposure to inflation-oriented assets, and

as such, may exhibit higher levels of liquidity risk. While both components may utilize

strategies that gain exposure to inflation through price appreciation and/or cash flows, the

Public component return contributions tend to be more appreciation-oriented, whereas the

Private component tends to be more evenly split between appreciation and cash flows.

B. Purpose

The total portfolio is expected to produce a long-term return in excess of inflation. While

an inflation risk premium is typically priced into most assets, unexpected changes in

inflation and/or higher-than-average structural inflation can often be the most damaging to

a plan sponsor’s purchasing power. As a result, the Real Return class seeks to provide the

Plan with diversification and protection against unanticipated changes in inflation and/or

higher-than-average inflation. Due to this feature, the Real Return class is expected to

increase the purchasing power of the total portfolio’s assets over time, while limiting

drawdowns during inflation-oriented crises.

By diversifying into the two major Real Return components (Pubic Inflation-Linked and

Private Inflation-Linked), the Real Return class seeks to moderate its risk profile versus

investing solely in any one component. This approach seeks to provide the Plan with a

more robust portfolio of inflation exposures.


Major

- Inflation Risk

Minor


- Liquidity Risk

- Growth Risk


SECTION F PAGE | 2

F.2. Class Structure

A. Components

The Real Return class consists of two major components: Public Inflation-Linked and

Private Inflation-Linked.

Public Inflation-Linked

Strategies currently included in this component are:

- Global Inflation-Linked Fixed Income (GILS)

- Collateralized Commodity Futures

Private Inflation-Linked

Component includes a spectrum of relatively illiquid investment strategies that are

known to have close linkages to changes in inflation. Private Inflation-Linked

strategies currently included in this component are:

- Timber

- Agriculture

- Infrastructure

Other inflation-oriented investment strategies considered for Private Inflation-Linked

include:

- Unlevered / Low-Levered Core Real Estate

B. Modifications to Component Structure

Modifications to the Real Return class’s component structure can take four forms:

i. Adding or deleting a specific investment strategy within a specific component;


iii. Establishing allocation levels and ranges among the components;

iv. Establishing strategy allocation levels and ranges within the components.

Modifications to the Real Return’s component structure will occur only with approval of



SECTION F PAGE | 3

C. Components’ Allocations and Allocation Ranges

The Real Return class’s allocation targets and allocation ranges among its two major

components is as follows (as a percent of total Real Return class assets):

Long-term Real Return Class Component Allocation Policy

Component Lower Limit Allocation Target Upper Limit

Public Inflation-Linked 20% 50% 80%

Private Inflation-Linked --- 50%* ---

* Due to the illiquid nature of the Private Inflation-Linked component, its allocation will be based on pre-

established policy allocation targets, and likely not fluctuate dramatically

Interim Real Return Class Component Allocation Policies

Target

Structure

1/1/2015

Target

Structure

1/1/2016

Target

Structure

1/1/2017

Target

Structure

1/1/2018

Public Inflation-Linked 70% 63% 56% 50%

Private Inflation-Linked 30% 37% 44% 50%

Total 100% 100% 100% 100%

D. Management of Components

To manage the assets assigned to the Real Return class components, the Board of Trustees

(“Board of Trustees” or “Board”) of the Employees’ Retirement System of the State of

Hawaii (“ERS”) utilizes a selection of external investment managers (“investment

managers”). Per policy, the Board delegates the investment manager selection process to

the ERS’s investment consultants (“investment consultants”) and ERS investment staff

(“Investment Staff”), but retains final decision authority for selecting managers for a

specific investment mandate. Investment Staff is also expected to manage the components’

allocations to align with their respective allocation targets over time. From time-to-time,

based on market dynamics and trends, Investment Staff has the discretion to vary each

respective component’s allocation away from the allocation target, but always within the

upper and lower limits as shown in the table under Section C. above. Investment Staff is

responsible for reporting to the Board component allocation levels that vary materially

from their allocation targets.

Within each component, assets are allocated across a series of mandates and/or investment

styles. In combination, these mandates and styles capture a broad, representative sampling

of the available investment opportunity set within the specified component. The

mandate/style allocations within each component are as follows:


SECTION F PAGE | 4

Public Inflation-Linked Component Allocation Policy

GILS – 50% Commodities – 50%*


Active 0% Active 100% *Mandate is currently unfunded as of 1/1/2018

Private Inflation-Linked Component Allocation Policy

Timber – 25-35% Agriculture – 15-25%* Infrastructure – 40-60%


Active 100% Active 100% Active 100% *Mandate is currently unfunded as of 1/1/2018

E. Components’ Managers and Managers’ Allocations


Board delegates investment authority to external investment managers. The ERS’s

investment consultants and Investment Staff have joint authority for identifying and

selecting investment manager candidates for specific investment mandates. The Board has

final authority over the selection of specific managers for each mandate. Investment Staff

has the authority to manage the allocation to each investment manager. Under this

authority, Investment Staff may reduce funding to one or more specific manager(s) and/or

increase funding to one or more specific manager(s) as long as the risk profile of the

component or sub-component is maintained. The investment manager allocations within

each component mandate are as follows:

Public Inflation-Linked Component Manager Allocation Policy

GILS – 50% Commodities – 50%*

Passive – BlackRock 100% Active – TBD TBD


Active 0% Active 100% *Mandate is currently unfunded as of 1/1/2018

Private Inflation-Linked Component Manager Allocation Policy

Timber – 25-35% Agriculture – 15-25%* Infrastructure – 40-60%

Active – Hancock 100% Active – TBD TBD Active – KKR 100%


Active 100% Active 100% Active 100% *Mandate is currently unfunded as of 1/1/2018


SECTION F PAGE | 5

F.3. Return Objectives & Risk Profile


Within the Real Return class, the standards for component performance reporting vary

materially. Keeping this factor in mind, the ERS utilizes the target benchmark below to

monitor the performance results of the aggregate Real Return class:

CPI + 3%

The Real Return class portfolio is expected to outperform the above benchmark, net of

fees, over a full investment cycle. An appropriate measure of an investment cycle would

be rolling 5-year periods. The Real Return class portfolio should outperform its


The Public Inflation-Linked component portfolio is expected to outperform the following

custom target benchmark, net of fees, over the majority of rolling 5-year periods:

50% Barclays WGILB Index (hedged) +

50% Barclay CTA Index

The Private Inflation-Linked component portfolio is expected to outperform the

following custom blended benchmark, net of fees, over the majority of rolling 10-year

periods:

30% NCREIF Timber +

20% NCREIF Farmland +

50% CPI + 4%

The Private Inflation-Linked benchmark will be lagged one quarter to align with

performance reporting. A longer measure of an investment cycle is used for the Private

Inflation-Linked component due to the long-term funding nature of investments within

the component.


In aggregate, the Real Return class is designed to provide consistent and relatively stable

returns above inflation during non-volatile periods, as well as serve as a hedge against

unanticipated inflation during inflationary periods. Based on current capital market

assumptions and the Real Return class’s long-term structure, there is an extremely low

probability that this class will lose any of its capital over a 10 year period. While not

producing the bulk of Plan’s investment returns, the Real Return class is positioned to

provide nominal returns near 5.5-6%/year over the long-term. This class is meant to

complement the high volatility associated with the Broad Growth class, while providing a

level of return moderately above the Principal Protection class. A strategic allocation to

the Real Return class should provide an improved level of diversification for the total

portfolio. The class may be negatively impacted by periods of stagnant/declining economic

growth and deflation.


SECTION F PAGE | 6

The aggregate Real Return class does not have an active risk (tracking error)

threshold/budget due to the stable nature of the class benchmark (CPI + 3%), and the

difficulty of benchmarking a class containing private markets investments on a continuous

basis.


The ERS is expected to manage the Public Inflation-Linked component portfolio by

utilizing passive management (i.e., very low tracking error) around the respective

benchmark discussed under Section F.3.A. above. Causes of tracking error away from the

benchmark may be due to modest sector/style biases, timing of manager funding and

rebalancing, and benchmark tracking risk. The allowable tracking error range for the

Public Inflation-Linked component is:

Tracking Error Ranges – Key Real Return Class Components Component Allowable Tracking Error

Public Inflation-Linked 0.0% - 1.0%/year

Private Inflation-Linked does not have an active risk threshold/budget due to the difficulty

of benchmarking private markets investments on a continuous basis.


SECTION F PAGE | 7

F.4. Manager Investment Guidelines


Statutes, the Derivatives Policy and Watch Criteria in the Appendix of this section, and the following

guidelines:

A. Public Inflation-Linked Manager Guidelines

Passive Global Inflation-Linked Fixed Income (GILS)

Manager(s): BlackRock



Component: Public Inflation-Linked

Benchmark: Bloomberg Barclays World Government Inflation-Linked Bond Index

(USD hedged)




- Cash equivalent portion shall not exceed 5%.

Permitted Investments include but are not limited to:

- Benchmark securities

- Inflation-linked and nominal bills/notes/bonds issued by countries

represented within the benchmark.

- Cash and money market instruments.

- Currency forward contracts for hedging currency risk relative to the

benchmark.

- Futures contracts for duration hedging, cash management, and other

efficient portfolio management purposes.

Credit Quality

- Securities in the portfolio will reflect the credit quality of the bonds in

the benchmark and the average credit quality will be in-line with the

benchmark.

- In case of a downgrade leading to an issuer dropping out of the

benchmark, the downgraded security may be held for up to one month.

Currencies

- Currency exposures cannot deviate in aggregate more than +/- 2% from

benchmark currency exposures.

.


SECTION F PAGE | 8

R E A L R E T U R N : A P P E N D I X


SECTION F PAGE | 9

Derivatives Policy







The notional value of the options may not exceed the total value of the underlying securities.



Futures –bond futures, money market futures, and currency futures where the manager has the

authority to invest in the underlying or deliverable cash market security.





market instrument.

Swaps – where the manager has the authority to invest in the underlying cash market instrument.

Minimum counterparty rating: A-


traded.


noted.




Cross-hedging is permitted for managers who are measured against a benchmark that contains non-USD

securities. Additionally, these managers may also use certain developed-market currencies as proxies for

otherwise illiquid emerging-market currencies. In such cases, use of such proxies will be disclosed

through the ongoing reporting process. The counterparties for foreign currency derivatives must be rated

A- or equivalent.










SECTION F PAGE | 10

0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00%

Watch Threshold -0.41% -0.82% -1.23% -1.63% -2.04% -2.45% -2.86% -3.27% -3.68% -4.08%


Watch Threshol -0.17% -0.33% -0.50% -0.67% -0.85% -1.02% -1.20% -1.38% -1.55% -1.73%


Watch Threshold 0.995 0.991 0.986 0.981 0.976 0.971 0.966 0.961 0.956 0.951


5.50% 6.00% 6.50% 7.00% 7.50% 8.00% 8.50% 9.00% 9.50% 10.00%

Watch Threshold -4.49% -4.90% -5.31% -5.72% -6.13% -6.53% -6.94% -7.35% -7.76% -8.17%


Watch Threshol -1.92% -2.10% -2.29% -2.47% -2.66% -2.85% -3.04% -3.24% -3.43% -3.63%


Watch Threshold 0.946 0.940 0.935 0.929 0.924 0.918 0.912 0.907 0.901 0.895


Long-Term

(5-year)

Short-Term

(1-year)

Medium-Term

(3-year)

Long-Term

(5-year)

Tracking Error

Tracking Error

Short-Term

(1-year)

Medium-Term

(3-year)


Short-Term Criteria (public inflation-linked mandates):


Medium-Term Criteria (public inflation-linked mandates):


Long-Term Criteria (public inflation-linked mandates):




Rationale:













Performance-related criteria for private inflation-linked mandates are

specified within the corresponding sub-component sections.


SECTION F PAGE | 11

TABLE OF CONTENTS

Page

I. INVESTMENT OBJECTIVES ................................................................................................................ 13

A. INVESTMENTS IN TIMBERLAND ASSETS .............................................................................. 13

B. STRATEGIC ALLOCATION ......................................................................................................... 13

C. PORTFOLIO PERFORMANCE ..................................................................................................... 14

1. Total Return (Income Plus Realized and Unrealized Gain/Loss) ............................................. 14

2. Risk with Regard to Individual Properties ................................................................................. 14

D. PROGRAM MANAGEMENT ........................................................................................................ 14

1. Institutional Quality ................................................................................................................... 15

2. Diversification ............................................................................................................................. 15

3. Ownership Structure .................................................................................................................. 15

4. Reporting System ...................................................................................................................... 16

5. Performance Measurement ........................................................................................................ 16

II. INVESTMENT POLICIES ....................................................................................................................... 16

A. ELIGIBLE INVESTMENTS ........................................................................................................... 16

B. GEOGRAPHICAL LOCATION DIVERSIFICATION ................................................................... 17

C. TREE MATURITY DIVERSIFICATION ...................................................................................... 17

D. TREE SPECIES DIVERSIFICATION ............................................................................................ 17

E. END USE DIVERSIFICATION ...................................................................................................... 17

F. TRACT AND PARCEL DIVERSIFICATION ................................................................................ 17

III. PROCEDURES FOR TIMBER PROGRAM MANAGEMENT ............................................................ 18

A. INVESTMENT PROCEDURE .......................................................................................................... 18

B. MANAGER RESPONSIBILITIES.................................................................................................... 18

1. Investment Management ............................................................................................................. 18

2. Portfolio Accounting and Financial Control ............................................................................... 20

3. Reporting Requirements .............................................................................................................. 20

T I M B E R S U B - C O M P O N E N T


SECTION F PAGE | 12

Appendices

Timber Annual Tactical Plan Outline – Appendix F.1

EMPLOYEES’ RETIREMENT SYSTEM OF THE STATE OF HAWAI‘I

TIMBERLAND PORTFOLIO POLICIES & PROCEDURES

I. INVESTMENT OBJECTIVES

A. INVESTMENTS IN TIMBERLAND ASSETS

The Employees' Retirement System of the State of Hawaii (“ERS”) has determined that, over the

long-term, inclusion of direct equity timberland investments and any other timberland-related

investments (“timber investments”), as allowed for in these Timberland Portfolio Policies &

Procedures would enhance the ERS’s expected portfolio investment characteristics. Expected

benefits to the ERS include: (1) the possibility of competitive rates of return with publicly traded

securities, (2) returns that have a low correlation with those associated with other major strategic

classes, and (3) a hedge against unexpected inflation. The use of timber investments will diversify the

portfolio's source of overall long-term expected real return, and reduce year-to-year portfolio

volatility.

Timber investments involve the privately negotiated purchase and, to a lesser degree, leasing of

forestland tracts, upon which trees are grown for commercial sale. Investments in timber will be made

directly through a separate account or indirectly through a multi-investor structure (i.e., two or more

investors investing in a specific timber asset as a limited liability company [“LLC”] or other

investment vehicle, as appropriate) in which ERS’s separate account is an investor. Investments will

be managed by a qualified timberland investment manager (“timberland manager” or “manager”).

Eligible timber investments are further described in Section I.D. Other portfolio parameters are

further described in Section II.A.

The investment policies of the ERS are determined by the ERS Board of Trustees (“Board of

Trustees” or “Board”). In general, the goal of the ERS is to obtain the optimum return on the portfolio

consistent with the assumption of prudent risk.

Timber investments of the ERS shall be made in a manner consistent with the fiduciary standards of

the prudent expert rule: (1) for the sole interest of the ERS’s participants and their beneficiaries; and,

(2) to safeguard and diversify the timber portfolio. The selection and management of timber assets

will be guided to preserve investment capital, to maintain prudent diversification of assets. The

diversification objective is required to mitigate overall market risk and the specific risks inherent in

any single property. Management, administrative and other responsibilities for the timberland

portfolio will be clearly delineated.

B. STRATEGIC ALLOCATION

The ERS’s allocation to timber investments shall remain within the limits authorized by the Board of

Trustees. The target allocation is 12.5-17.5% of the Real Return strategic class (25-35% of the Private

Inflation-Linked Component).


SECTION F PAGE | 13

C. PORTFOLIO PERFORMANCE

The ERS shall use the following rate of return tests to evaluate the performance of the timber

investment portfolio:

1. Total Return (Income Plus Realized and Unrealized Gain/Loss)

Over rolling 5-year periods, the total timber investments portfolio is expected to generate a

minimum total real time-weighted rate of return of 6%, net of all investment management fees

and expenses. The inflation measure employed to benchmark the real rate of return calculation

will be CPI-U. The timber investments portfolio’s rate of return is expected to be generated

substantially from the following sources:

A material component of return on the portfolio will be from the biological growth of the

timber.

A material component of return attributable to the portfolio will be moderate cash income

from the sale of timber inventory.

Long-term, a component of return will result from capital gains through active management,

from improving property values and opportunistic purchases and sales of properties.

The manager will also exploit other opportunities for increasing the rate of return, such as

usage leases and easements, moderate use of leverage as permitted by Section II.A, below,

and other active management techniques.

The portfolio and individual investments will be compared to an appropriate timber index (such

as the NCREIF Timberland Index), or other relevant proxies as appropriate. In any event, the 6%

minimum real rate of return hurdle will apply.

2. Risk with Regard to Individual Properties

In timber investing there exists the risk of sustaining a loss on any of the individual property

investments. It is the ERS’s expectation that, while specific investments may incur losses of all

or part of the capital invested, a diversified portfolio of holdings will produce a positive rate of

return at least equal to the expected minimum set forth in Section I.C.1., above.

D. PROGRAM MANAGEMENT

The selection and management of assets in the timber investments portfolio will be guided to generate

a high level of risk-adjusted return, to provide current income, and to maintain prudent diversification

of assets and specific investments.

With timber investments, there exists an inherent risk that the actual return of capital, income and

gains will vary from the amounts expected. The investment risk associated with timber investments

will be mitigated through both the structure of these Timberland Portfolio Policies & Procedures and

the actions of the timberland manager. The key program management parameters are as follows:


SECTION F PAGE | 14

1. Institutional Quality

All assets must be of institutional investment quality. Institutional quality will be defined as

being of a quality whereby the investment would be considered acceptable by other prudent

expert institutional timber market participants and corporate forest product industry investors.

2. Diversification

Diversification reduces the chance of an adverse impact suffered by any one holding or

investment type from adversely affecting a disproportionate share of the total portfolio. The

timber portfolio shall be diversified by:

regional geographical location (South, Northeast, West, Other, and International)

non-contiguous tract and parcel locations

type and species of tree (e.g., softwood “conifer,” such as pine, fir redwood, etc., and

hardwood “deciduous,” such as oak, maple, etc.)

end-use market of forest product (building and construction, pulp and paper, furniture and

decorative wood)

potential purchasers of inventory (mills and processing plants)

stage of tree growth (seedling through mature)

timing of investment

Investments will be made such that no single property purchase will represent more than 25% of

the fully invested target net asset value of the allocation. These limits are subject to waiver on a

case-by-case basis by the Trustees. It is also recognized that during the portfolio development

and wind-down stages the full investment parameters may not, of necessity, be met.

Long-term diversification target ranges among eligible investments will be set forth in Section II

of this document, and reviewed annually or more often as necessary. Interim investment goals

for the implementation of the Portfolio will be set forth in an Annual Tactical Plan (Appendix

IV.4 - A), as described herein.

3. Ownership Structure

Account and Investment Structure: The ERS’s ownership structure will comprise an arrangement

whereby separate account relationships will be established with one or more fiduciary timberland

managers. The separate account timberland manager will in turn purchase, on a discretionary

basis, timber assets for the ERS’s account. The separate account may be structured as an LLC or

employ other holding vehicles, as appropriate (e.g., 501(c) corporation, insurance annuity

contract, group trust, etc.), to shield the ERS from potential tax and general liabilities. The timber

investments will be subject to the standards and parameters established in this Timberland

Portfolio Policies and Procedures and the ERS’s approval of an Annual Tactical Plan. The ERS

will be the sole beneficial owner of all properties, and assets held for the ERS will not be

commingled with any other investor or owner, subject to the following exceptions:

(a) Multi-Investor Structures: Multi-investor structures consisting of two or more institutional

investors pursuing a specific timber asset under an LLC or another investment vehicle may

be used, provided that: (1) the ERS is shielded from potential tax and general liabilities; and

(2) multi-investor structure investments may not comprise more than 25% of the portfolio

based on timberland market value at the time of acquisition.

(b) Board Waivers: Investments not wholly owned by the ERS (other than investments held

under a multi-investor structure, as provided in (a), above, or in joint ventures, as provided


SECTION F PAGE | 15

in (c) below, may be purchased by the manager, subject to review by and only upon prior

approval of the Board.

(c) Joint Ventures: Investment managers may undertake joint venture arrangements with forest

product industry companies for up to 20% of the portfolio; however, joint ventures are

allowable only if the ability of the ERS to dispose of the property in an arms-length

transaction at fair market value is not impeded.

4. Reporting System

There shall be a comprehensive reporting and monitoring system for the entire portfolio.

Situations of underperforming investments, portfolio diversification deficiencies from the

Timberland Portfolio Policies and Procedures, and conflicts of interest can then be identified,

facilitating active portfolio management. Further definition of this reporting system is provided

in Sections III.C.2.b. “Investment Management Ongoing Operations” and III.C.3. “Investment

Management Portfolio Accounting and Financial Control.”


The timberland manager will provide cash flow, valuation, and any other requested information

to the ERS investment staff (“Investment Staff”), and the ERS’s real estate consultant (“Real

Estate Consultant”) quarterly, and the ERS’s custodian bank (“custodian”) on a monthly or

quarterly basis, as required by the ERS.

Performance will be calculated on a time-weighted basis. The rate of return calculations will be

net of all fees and expenses. So that the performance numbers reported by the manager and the

custodian bank shall be the same, the manager will be responsible for reviewing the custodian’s

figures and bringing any discrepancies to reconciliation.

Benchmarks: The ERS will employ an absolute rate of return benchmark of a 6% real rate of

return over rolling 5-year periods. Other appropriate performance comparisons will also be

examined, such as an appropriate timber index or other relevant proxies (e.g., the NCREIF

Timberland Index).

II. INVESTMENT POLICIES

Long-term target diversification ranges will guide the timber investment program. Each year the program

will be further implemented or modified in accordance with an Annual Tactical Plan prepared by the

timberland manager, reviewed by Investment Staff and the Real Estate Consultant, and approved by the

Board.

A. ELIGIBLE INVESTMENTS

In general, the timberland manager will have discretion to purchase forest tracts that are expected to

meet or exceed the ERS’s rate of return objectives for timber investment. The rate of return must be

appropriate after the consideration of any risk measures employed by the manager. Multi-investor

structure investments may not comprise more than 25% of the portfolio based on timberland market

value at the time a multi-investor structure is made. Lease holdings may comprise no more than 30%

of the portfolio, with the remainder of holdings being fee simple. The timberland manager is allowed

to enter into joint ventures with forest product companies for up to 20% of the portfolio. However,

the structure of the joint venture must not impede, at any time, either the sale of the holding or the

ability of the ERS to replace the timberland manager. Also, the manager will minimize the


SECTION F PAGE | 16

concentration of holdings in areas known to be frequented by natural disasters, for example coastal

tracts known to be frequent hurricane paths, flood zones, etc.

Without compromising the geographical diversification targets, the timberland manager will use

reasonable efforts to mitigate the incurrence of unrelated business taxable income in the portfolio.

Leverage may be used, on a nonrecourse basis, up to 20% of the timberland market value of the

portfolio, with no more than 50% leverage on any one timber investment. The single investment debt

level will be measured for compliance at the time leverage is added to the portfolio. Leverage for the

total portfolio will be measured for compliance at the time the leverage is added to the portfolio or a

portfolio asset is purchased or sold. Leverage may not be added to any investments held as of

September 15, 2010.

B. GEOGRAPHICAL LOCATION DIVERSIFICATION

Over the long-term, the ERS portfolio should seek portfolio diversification with regard to major US-

domestic timber growing regions. The timberland manager may seek to diversify internationally up

to 20% of the portfolio based on timberland value of the portfolio at the time the investment is made.

The currency exposure to the ERS from any non-U.S. dollar aspect of the allocation is expected to be

negligible over the long-term.

The following ranges set forth the geographic diversification targets for the timberland manager to

fulfill:

Region Range Midpoint

South 45% - 65% 55%

West 25% - 45% 35%

Northeast 0% - 20% 10%

Other/International 0% - 20% 10%

C. TREE MATURITY DIVERSIFICATION

The ERS portfolio will seek to diversify by maturity of timber ranging from immature, pre-

merchantable trees through mature, merchantable timber. The timberland manager will create a

sustainable timberland portfolio where tree seeding, planting, growth and purchases will replace trees

harvested and properties sold.

D. TREE SPECIES DIVERSIFICATION

The portfolio will be diversified by timber type and include both hardwoods and softwoods.

E. END USE DIVERSIFICATION

The ERS portfolio will be structured to sell into several commercial industries, such as paper goods

and cardboard, various building and construction materials markets, and finished carpentry and

furniture. The timberland manager will also take into account the number of regional processors or

purchasers of timber inventory.

F. TRACT AND PARCEL DIVERSIFICATION

The portfolio will be composed of numerous non-contiguous tracts with the goal of diversifying the

risk of natural disasters such as fire, disease, pests, etc.


SECTION F PAGE | 17

III. PROCEDURES FOR TIMBER PROGRAM MANAGEMENT

A. INVESTMENT PROCEDURE

Timber investments in compliance with these Timberland Portfolio Policies & Procedures (Section

II: Investment Policies and Section II: Investment Objectives) shall be made and managed through

the following process:

1. Timber Acquisition, Management and Disposition: Periodically, the Investment Staff and the

Real Estate Consultant will review and modify, as necessary, the Timberland Portfolio Policies

and Procedures that specify long-term diversification parameters for the timberland investment

portfolio. Any modifications to the plan will be incorporated as necessary. The Timberland

Portfolio Policies and Procedures will then be submitted to the Investment Staff for review and

the Board of Trustees for final approval.

2. Annual Tactical Plan: Annually, the timberland manager will prepare an Annual Tactical Plan

which reviews the current status of the portfolio, recent historical and prospective market

conditions, and proposes the steps to be taken over the next twelve month period to further

implement the long-term strategic plan. The Annual Tactical Plan will be reviewed by the Real

Estate Consultant and Investment Staff and approved by the Board. The outline for the Annual

Tactical Plan is provided in Appendix IV.4 - A.

B. MANAGER RESPONSIBILITIES

1. Investment Management

Timberland managers are directly accountable for the following investment management

responsibilities. This section designates certain investment responsibilities that the timberland

manager will perform or cause to be performed.

a. Acquisition – The manager will be responsible for sourcing, evaluating and selecting, on a

discretionary basis with fiduciary responsibility, timber investments to be made on behalf of

the ERS.

The acquisition process will be made with a view to maximize the ERS’s risk adjusted rate

of return, within the portfolio diversification parameters set forth in the Objectives, Policies,

and Program Management sections of these Timberland Portfolio Policies & Procedures.

The process will include, but not be limited to, the following services:

(1) Review and maintain a record of opportunities available in the market over time.

(2) Evaluate opportunities and identify investments that will provide the most attractive risk

and return characteristics, and are in accordance with the long-term and short-term

objectives of the portfolio.

(3) Conduct full and proper acquisition due diligence and fully document the process. Due

diligence will be conducted to a standard of completeness attributable to a prudent

expert. Prospective investments will be inventoried and evaluated on the timberland

manager’s financial model at an appropriate discount rate, in determining appropriate

acquisition pricing.


SECTION F PAGE | 18

The timberland manager will make available for review by the ERS, or its agents,

the manager’s policies, procedures, and standards for conducting property

evaluation and due diligence and the due diligence documentation performed on

any investment made on the ERS’s behalf.

(4) Negotiate purchase agreements and other closing documents on the ERS’s behalf, with

a view to maximize returns, minimize expenses, safeguard the ERS’s assets, and secure

investor rights, and make timberland investments on the ERS’s behalf.

b. Ongoing Operations – The timberland manager shall manage or cause to be managed, the

portfolio and individual properties such as to enhance the ERS’s value in the investment.

The manager shall be responsible for conducting or supervising the following services with

respect to each investment:

(1) Management Plan – The manager will develop and execute a management plan for each

holding and the overall portfolio to maximize the value of the investments for the ERS.

(2) Property Management – The manager will monitor budgeted versus actual performance

for the properties and shall take all necessary or appropriate steps consistent with

applicable capital and operating budgets to assure the ERS’s investment is managed to

or above its anticipated performance level. This process will involve applying

silvicultural6 and other forest management techniques to maximize inventory yield and

property value, and minimize risk of loss. It will also involve techniques to maximize

return and provide cash flow, such as negotiating hunting and usage leases.

The manager shall keep itself informed of the overall market conditions relative to the

managed investments and the managed investments’ valuations. The manager will

also be responsible for ensuring compliance with all environmental and other

governing laws. All such activities will be undertaken with the intention to maximize

value to the ERS.

(3) Sale of Timber Inventory – The manager will maintain an awareness of current market

pricing and future pricing forecasts, and sell inventory according to the management

plan, or opportunistically as determined at the manager’s discretion.

(4) Valuation and Appraisals – Properties will be appraised by an outside appraiser at least

every three years, or as necessary. Appraisals will also be updated by an outside

appraiser, as necessary or requested by the manager. The manager will provide updated

valuations of each investment quarterly, based on inventory measures and updated

outside appraisals as available.

(5) Disbursement, Receipt and Cash Management – The manager will develop procedures

for funding investment on a timely basis and coordinating the receipt of cash

distributions from the sales and other income sources.

c. Disposition – Ongoing, and based on timber market circumstances, the timberland manager

shall review the managed investments with respect to continued timely return of capital,

income and gains, including both planned and opportunistic sales of timber inventory and

6 Silviculture is the theory and practice of controlling the establishment, composition and growth of forests. Examples of silvicultural practices include planned cutting, planting,

thinning, fertilizing, proper drainage, controlling insects and other similar activities.


SECTION F PAGE | 19

properties. The manager shall identify qualified buyers, solicit and evaluate offers, and

negotiate property sales.

2. Portfolio Accounting and Financial Control

The timberland manager's accounting, reporting, financial control, and administration systems

shall meet the following objectives:

a. Financial Control – The manager will provide control systems to protect assets, detect errors

and insure the reliability of information generated by the accounting system.

(1) Books and Records – The manager shall maintain books of account with correct entries

of all receipts and expenditures incident to the management of the investment. These

books, together with all records, correspondence, files and other documents, shall at all

times be open to the inspection of the ERS. The manager shall maintain complete and

accurate records of all transactions related to the managed investment, including receipts

and all correspondence relating thereto on such forms as the ERS’s auditors may

reasonably require and make such records available for inspection and copying by the

ERS at all reasonable times. The manager shall bear the costs associated with the

retention of such records and if the ERS shall request copies of such records, the

manager shall bear the cost of duplicating and sending such records to the ERS.

b. Financial Statements – On a quarterly basis, the timberland manager will create unaudited

financial statements, and annually, audited financial statements for the overall portfolio.

c. Accounting Policies – Accounting policies for the ERS are outlined below:

(1) Current Value Reporting – Accounting data shall be computed using current values. The

timberland manager will report performance in compliance with the CFA Institute

standards, or other appropriate standards as agreed to with the ERS. The manager will

be held to a standard of a prudent expert in valuing the underlying value of the

investments.

3. Reporting Requirements

a. Manager Quarterly Report – On a quarterly basis, within 45 days following the quarter-end,

the timberland manager shall provide the Investment Staff and Real Estate Consultant with

a report on the portfolio which will address activities occurring during the prior quarter, an

updated list of holdings, cash flows, valuations, return calculation, and any and all other

items of which the ERS should be apprised.

b. Custodian Bank Monthly Statement – On a monthly basis, the timberland manager shall

provide the ERS’s custodian a report of the ERS’s account cash flows and valuations, and

any other information reasonably requested.

c. Funding Procedures – The timberland manager shall provide the ERS, on a best efforts basis,

with ten (10) business days notice of funding for purchases. The ERS shall also be provided

with documented wiring instructions in advance.

d. Annual Tactical Plan – Within 60 days of calendar year end, the timberland manager will

submit an Annual Tactical Plan for review by the Investment Staff and the Real Estate

Consultant, and for approval by the Board of Trustees. The Annual Tactical Plan (outlined


SECTION F PAGE | 20

in Appendix IV. 4 - A) will include: (1) a review of the current status of the portfolio, (2)

perceived investment environment, (3) the types and amount of property investments to be

sought and underlying rationale, (4) goals for other management responsibilities such as

situations being monitored and adding value, and (5) outline the steps anticipated toward

portfolio development over the course of the coming fiscal year.

e. Notice – The timberland manager shall notify the Investment Staff and Real Estate

Consultant as soon as practicable in writing of any investigation, examination or other

proceeding involving the timberland investments commenced by any regulatory agency or

of any action, suit or proceeding commenced against or by the manager or any parties

affiliated with the portfolio.

f. Other Information – The timberland manager will also provide any other reasonable

information requested by the Investment Staff, or the ERS’s custodian, the Real Estate

Consultant or other agent of the ERS.


SECTION F PAGE | 21

APPENDIX F.1

EMPLOYEES’ RETIREMENT SYSTEM OF THE STATE OF HAWAI‘I

TIMBER ANNUAL TACTICAL PLAN GUIDELINES

Tactical Plan: The Tactical Plan is a report which outlines the steps to be taken in the next 12 month period to

further implement the timber portfolio, and any other actions or considerations germane to the active

management and success of the portfolio. It also documents the reasons for the particular courses of action to

be taken, and importance of items under consideration.

The Investment Staff and Real Estate Consultant shall review the Annual Tactical Plan, submit comments, and

recommend approval of the finalized plan to the Board of Trustees. All sections should be as brief as possible

using a format as follows:

I. FUNDING LEVEL

Annual Tactical Plan Period: 1/1/xx through 12/31/xx

A. Funding Tables:

1. Current Funding Position (As of x/xx/xx)

Total Fund Market Value $xx billion

Market Value (Excl. Multi-Investor Structure Investments) $xx billion

Multi-Investor Structure Investments $xx billion

Target for Timber $xx million

Current Net Asset Value Deficit/(Surplus) $(xx) million

2. Discuss any planned undertakings with respect to the allocation’s size in the next 12 months.

3. Leverage – List individual investments where leverage is used and the specific dollar and percentage

amount of leverage used on the investment. Also state the total percentage and dollar amount of

leverage used relative to the total portfolio timberland market value.

II. DIVERSIFICATION AND PORTFOLIO STATUS

A. Geographic Diversification

% Range $ NAV % NAV

South 45-65 0 0%

West 25-45 0 0%

Northeast 0-20 0 0%

Other* 0-20 0 0%

International* 0-20 0 0%

Totals 0 100%

Note: While Other and International are listed separately,

the combined total of the two will not exceed 20%.

1. Discuss all planned undertakings with respect to the allocation’s geographic diversification

in the next 12 months.


SECTION F PAGE | 22

2. Discuss the outlook for each region regarding property purchase and sales, timber prices,

and any other relevant factors.

B. Timber Maturity – Discuss the composition and plans for the portfolio with respect to biological

maturity.

C. Species, End-Use, Tract & Parcel Diversification – Describe and comment on the portfolio’s

diversification with regard to the listed considerations and any specific actions to be undertaken.

D. Current Status of the Portfolio – Comment on the portfolio’s current status with regard to any other

material considerations and specific actions to be undertaken. Include comments specific to the

portfolio’s:

1. Return

2. Risk

3. Diversification

4. Leverage

III. MARKET ENVIRONMENT

A. Recent Past – Discuss the market environment in which the portfolio has been operating for the past

year, and any ramifications.

B. Coming Year – Discuss the expected market environment for the next year, and any ramifications.

C. Are any material transactions planned or anticipated in the next year? If so, discuss the underlying

rationale.

IV. PORTFOLIO MANAGEMENT

A. Discuss objectives and plans for other portfolio or property management responsibilities, such as situations

being monitored and adding value, property sales, etc.

B. Specific situations being monitored, underperforming investments.

C. Discuss projected changes in capital calls and distributions.

D. Other items relevant to the ERS’s portfolio and any items of which the Board should be apprised.

SUMMARY

Investment Objectives: Summary of basic goals for the portfolio for the next 12 months.


SECTION F PAGE | 23

TABLE OF CONTENTS

Page



B. INVESTMENT STRUCTURE ..................................................................................................... 25

C. DIVERSIFICATION ..................................................................................................................... 25

D. LEVERAGE .................................................................................................................................. 25

2. PERFORMANCE MEASUREMENT/BENCHMARKING .............................................................. 26

A. PORTFOLIO RISK AND LIQUIDITY ATTRIBUTES .............................................................. 26

B. LONG-TERM PERFORMANCE BENCHMARK...................................................................... 26

3. IMPLEMENTATION .......................................................................................................................... 26



C. MONITORING AND REPORTING ........................................................................................... 27

I N F R A S T R U C T U R E S U B - C O M P O N E N T


SECTION F PAGE | 24



The target allocation for Infrastructure is 20%-30% of the Real Return class. It is expected

that Infrastructure investments will be privately-held (e.g., limited partnerships or

equivalent). The Infrastructure Portfolio target is long term in nature (i.e., at least ten to

fifteen years, if not longer) and for time-diversification purposes investment commitments

may be drawn down over several years throughout a defined investment period with respect

to certain investment vehicles (e.g., closed-end pooled funds). Accordingly, ERS Staff and

the Consultants may recommend total investment commitments that reasonably exceed the

total Infrastructure Portfolio allocation authorized for Portfolio investment (e.g., 150% of

the authorized allocation amount) to build and maintain the allocation (over commit). The

scheduled amounts of such investment commitments shall be recommended by Staff and

Consultants and approved by the Board in the context of the Strategic Plan (see below).

B. Investment Structure

The Infrastructure Portfolio may include private equity and private debt investments in

closed-end pooled funds. Private equity fund investments may include equity interests in

Infrastructure assets, including energy, communications, transportation, and other types of

assets. Private debt fund investments may include structured investments, which provide

for stated preferred returns, which may be accrued or paid on a current basis.

C. Diversification

The Infrastructure Portfolio diversification is important in reducing portfolio risk and

accomplishing risk-adjusted return expectations in the context of the larger Real Return

strategic class that includes the Infrastructure component. The impact of Infrastructure

investments on the Real Return portfolio’s diversification, portfolio risk and risk-adjusted

returns shall be considered when evaluating prospective investments.

D. Leverage

Leverage can be a significant risk factor, impacting the risk / return profile of the

Infrastructure Portfolio. Staff and the Consultants will monitor closely the leverage level

of each Infrastructure fund investment seek to maintain a risk/return level consistent with

this Policy Statement. Average portfolio-level LTV is not expected to exceed 33% at cost.


SECTION F PAGE | 25

2. Performance Measurement/Benchmarking

A. Portfolio Risk and Liquidity Attributes

Infrastructure investments are expected to be private; therefore, on-demand liquidity

outside of income is not anticipated. Investments are expected to be “core” investments,

equity or debt investment in high-quality infrastructure assets with lower risk/return

attributes (e.g., a natural gas fired power plant with a long-term off-take contract with a

creditworthy counterparty). Core investments are often regulated or contracted essential

assets that may be characterized by a low correlation to GDP growth (e.g., regulated

utilities). Net total returns historically have been in the 4%-8% range (inflation-adjusted

and net of fund-level fees) and are typically comprised of greater levels of income with

appreciation matching or exceeding inflation. Volatility levels are anticipated to be

reduced by this focus on income-oriented investing.

B. Long-term Performance Benchmark

The long-term benchmark for the Infrastructure Sub-Component Portfolio is a net internal

rate of return (net IRR) that exceeds annual CPI+4%/year. At least half of the net IRR

should be attributable to ongoing cash flow versus capital appreciation due to asset sales

toward the end of the investment horizon. Net internal rates of return (net IRRs) should

also be calculated for the individual Agriculture investments as well as the aggregate

Agriculture Portfolio. These net IRRs should be compared to similar investments in the

marketplace.

3. Implementation

A. Strategic Plan

1. On at least a biennial basis, the General Consultant, in conjunction with Investment

Staff, will prepare a Strategic Plan for the aggregate Real Return class, which reviews

the current status of the Real Return class and its component portfolios, recent

historical and prospective market conditions, and proposes actions to be taken over

the next approximately 12-24 month period in Infrastructure as well as the other

components. This document will recommend general capital allocations to the

components and applicable investment strategies and the rationale and expectations

for inclusion.

2. The Strategic Plan will then be presented to the Board of Trustees for approval.



Infrastructure investment opportunity:

1. Staff and all consultants will seek to source attractive Infrastructure opportunities

that are consistent with these guidelines.


SECTION F PAGE | 26

2. In conjunction with the General Consultant, the CIO and appropriate senior staff

will determine which specific opportunities warrant further exploration. The CIO

will review the specific deal/fund search with the General Consultant to determine

its appropriateness in the context of the Strategic Plan. Once the opportunity meets

these criteria, the CIO will assign due diligence to a deal/fund team, which would

include the appropriate staff and recommending consultant.

3. If, after the appropriate due diligence, staff and the recommending consultant

determines that the investment opportunity merits a commitment from the ERS,

the recommending consultant will take the following steps:


investment merits, risks and key conclusions.


on this discussion and complete an Investment Disclosure Form.




Investment Staff and the recommending consultant on an investment

recommendation.


The performance of private Infrastructure investments will be calculated on both a time-

weighted and dollar-weighted (internal rate of return or IRR) basis, with primary emphasis

being placed on the internal rate of return. The rate of return calculations will be net of all

partnership/LLC fees and expenses.

ERS’ Real Assets (or Real Estate) Consultant will be responsible for calculating and

reporting net IRRs on the individual Infrastructure investments as well as the aggregate

Infrastructure portfolio on at least a semi-annual basis. ERS’ General Consultant, in

conjunction with ERS’ custodian, will produce time-weighted returns on each

Infrastructure investment and the aggregate Infrastructure portfolio in the context of the

broader Real Return portfolio.

So that the performance numbers reported by an Infrastructure manager and the custodian

are the same, the manager will be responsible for reviewing the custodian’s figures as to

timing, amount, value of in-kind securities at distribution and reported net asset value, and

reconciling and explaining any discrepancies. Investment Staff and/or the appropriate

designated retained consultant will provide additional performance measurement

information, if requested by the Board.


SECTION F PAGE | 27

TABLE OF CONTENTS

Page



B. INVESTMENT STRUCTURE ..................................................................................................... 29

C. DIVERSIFICATION ..................................................................................................................... 29

D. LEVERAGE .................................................................................................................................. 29

2. PERFORMANCE MEASUREMENT/BENCHMARKING .............................................................. 30

A. PORTFOLIO RISK AND LIQUIDITY ATTRIBUTES .............................................................. 30

B. LONG-TERM PERFORMANCE BENCHMARK...................................................................... 30

3. IMPLEMENTATION .......................................................................................................................... 30



C. MONITORING AND REPORTING ........................................................................................... 31

A G R I C U L T U R E S U B - C O M P O N E N T


SECTION F PAGE | 28



The target allocation for Agriculture is 7%-13% of the Real Return class. It is expected

that Agriculture investments will be privately-held (e.g., limited partnerships or

equivalent). The Agriculture Portfolio target is long term in nature (i.e., at least ten to

fifteen years, if not longer) and for time-diversification purposes investment commitments

may be drawn down over several years throughout a defined investment period with respect

to certain investment vehicles (e.g., closed-end pooled funds). Accordingly, ERS Staff and

the Consultants may recommend total investment commitments that reasonably exceed the

total Agriculture Portfolio allocation authorized for Portfolio investment (e.g., 150% of the

authorized allocation amount) to build and maintain the allocation (over commit). The

scheduled amounts of such investment commitments shall be recommended by Staff and

Consultants and approved by the Board in the context of the Strategic Plan (see below).

B. Investment Structure

The Agriculture Portfolio may include private equity and private debt investments in

closed-end pooled funds. Private equity fund investments may include equity interests in

Agriculture assets, including farmland, delivery, storage, and other types of assets. Private

debt fund investments may include structured investments, which provide for stated

preferred returns, which may be accrued or paid on a current basis.

C. Diversification

The Agriculture Portfolio diversification is important in reducing portfolio risk and

accomplishing risk-adjusted return expectations in the context of the larger Real Return

strategic class that includes the Agriculture component. The impact of Agriculture

investments on the Real Return portfolio’s diversification, portfolio risk and risk-adjusted

returns shall be considered when evaluating prospective investments.

D. Leverage

Leverage can be a significant risk factor, impacting the risk / return profile of the

Agriculture Portfolio. Staff and the Consultants will monitor closely the leverage level of

each Agriculture fund investment and seek to maintain a risk/return level consistent with

this Policy Statement. Average portfolio-level LTV is not expected to exceed 33% at cost.


SECTION F PAGE | 29

2. Performance Measurement/Benchmarking

A. Portfolio Risk and Liquidity Attributes

Agriculture investments are expected to be private; therefore, on-demand liquidity outside

of income is not anticipated. Investments are expected to be “core” investments, equity or

debt investment in high-quality Agriculture assets with lower risk/return attributes (e.g.,

farmland or ranchland that produce sustainable levels of income). Core investments may

be characterized by a low correlation to GDP growth. Net total returns historically have

been in the 4%-8% range (inflation-adjusted and net of fund-level fees) and are typically

comprised of greater levels of income with appreciation matching or exceeding inflation.

Volatility levels are anticipated to be reduced by this focus on income-oriented investing.

B. Long-term Performance Benchmark

The long-term benchmark for the Agriculture Sub-Component Portfolio is the NCREIF

Farmland Index, which is computed on a time-weighted basis. At least half of the

Portfolio’s time-weighted return should be attributable to ongoing cash flow versus capital

appreciation due to asset sales toward the end of the investment horizon. Net internal rates

of return (net IRRs) should also be calculated for the individual Agriculture investments as

well as the aggregate Agriculture Portfolio. These net IRRs should be compared to similar

investments in the marketplace.

3. Implementation

A. Strategic Plan

1. On at least a biennial basis, the General Consultant, in conjunction with Investment

Staff, will prepare a Strategic Plan for the aggregate Real Return class, which reviews

the current status of the Real Return class and its component portfolios, recent

historical and prospective market conditions, and proposes actions to be taken over

the next approximately 12-24 month period in Agriculture as well as the other

components. This document will recommend general capital allocations to the

components and applicable investment strategies and the rationale and expectations

for inclusion.

2. The Strategic Plan will then be presented to the Board of Trustees for approval.



Agriculture investment opportunity:

1. Staff and all consultants will seek to source attractive Agriculture opportunities

that are consistent with these guidelines.


SECTION F PAGE | 30

2. In conjunction with the General Consultant, the CIO and appropriate senior staff

will determine which specific opportunities warrant further exploration. The CIO

will review the specific deal/fund search with the General Consultant to determine

its appropriateness in the context of the Strategic Plan. Once the opportunity meets

these criteria, the CIO will assign due diligence to a deal/fund team, which would

include the appropriate staff and recommending consultant.

3. If, after the appropriate due diligence, staff and the recommending consultant

determines that the investment opportunity merits a commitment from the ERS,

the recommending consultant will take the following steps:


investment merits, risks and key conclusions.


on this discussion and complete an Investment Disclosure Form.




Investment Staff and the recommending consultant on an investment

recommendation.


The performance of private Agriculture investments will be calculated on both a time-

weighted and dollar-weighted (internal rate of return or IRR) basis, with primary emphasis

being placed on the internal rate of return. The rate of return calculations will be net of all

partnership/LLC fees and expenses.

ERS’ Real Assets (or Real Estate) Consultant will be responsible for calculating and

reporting net IRRs on the individual Agriculture investments as well as the aggregate

Agriculture portfolio on at least a semi-annual basis. ERS’ General Consultant, in

conjunction with ERS’ custodian, will produce time-weighted returns on each Agriculture

investment and the aggregate Agriculture portfolio in the context of the broader Real

Return portfolio.

So that the performance numbers reported by an Agriculture manager and the custodian

are the same, the manager will be responsible for reviewing the custodian’s figures as to

timing, amount, value of in-kind securities at distribution and reported net asset value, and

reconciling and explaining any discrepancies. Investment Staff and/or the appropriate

designated retained consultant will provide additional performance measurement

information, if requested by the Board.


SECTION G

H i T I P P R O G R A M

S E C T I O N: G


SECTION G

TABLE OF CONTENTS

Page

1. INTRODUCTION .................................................................................................................................. 1

2. POLICY .................................................................................................................................................. 2

A. BACKGROUND ............................................................................................................................. 2

B. GENERAL POLICY ....................................................................................................................... 2

C. OBJECTIVES .................................................................................................................................. 3

3. PROCEDURES ...................................................................................................................................... 5

A. PROCEDURES AND STANDARDS ............................................................................................ 5

B. STRATEGY .................................................................................................................................... 6

C. IMPLEMENTATION ..................................................................................................................... 8

D. MONITORING................................................................................................................................ 9

E. REVIEW AND MODIFICATION OF INVESTMENT POLICY STATEMENT ..................... 10


SECTION G PAGE | 1

G.1. Introduction

The Hawaii Targeted Investment Program (HiTIP) was created by the Employees’ Retirement

System of the State of Hawaii (“ERS”) to fulfill the mandate of Act 260, “A Bill For An Act Relating

To The Innovation Economy” (“Act 260”) passed by the Legislature and signed by the Governor in

July 2007. The purpose of Act 260 is “to encourage the employees’ retirement system to invest in

Hawai‘i venture capital…”

The HiTIP should be viewed as a distinct component of the broader ERS private equity program for

two distinct reasons. First, Act 260 stipulates that the ERS provide specific updates to the State of

Hawai‘i (“State”) with respect to the HiTIP. Second, the investment directives that apply to the HiTIP

are different than those that apply to the broader ERS private equity investment portfolio. Act 260

stipulates that the ERS require that the HiTIP earn returns for the ERS investment portfolio by making

investments in emerging growth and growth-oriented businesses in traded sector industries in

Hawai‘i.

In accordance with HRS chapter 88, the Board of Trustees of the ERS (the “Board”) determines the

investment policies and procedures for all ERS investment activities, including the HiTIP. ERS

employees will act as staff overseeing HiTIP and its fund-of-funds advisor and report HiTIP activities

to the Board, in conjunction with the fund-of-funds advisor. In this capacity, ERS investment staff

(“Investment Staff”) and/or the fund-of-funds advisor may periodically recommend new or updated

HiTIP investment policies and procedures to the Board for review and comment. HiTIP investment

policies and procedures, which are attached, reflect the following principles:

1. The purpose of the HiTIP is to produce competitive risk-adjusted investment returns for the

ERS by making investments in emerging growth and growth-oriented businesses in traded

sector industries, with specific emphasis on Hawai‘i. The HiTIP’s mission is not economic

development, but economic development may be one significant byproduct of the investment

program.

2. HiTIP funds will be invested only through external general partners/managers or co-

investments.

3. General partners/managers will be fully discretionary, i.e., after funds are allocated to the

limited partnership or limited liability company (“LLC”), they are totally responsible for

the investment of these funds within the partnership’s or LLC’s investment guidelines.

The Board and Investment Staff will delegate the selection, retention and monitoring of external

partnerships or LLCs to a dedicated fund-of-funds advisor (or manager-of-manager) and will not

entertain individual investment proposals from individual businesses or for particular projects, except

as a result of in-kind distributions of assets to the HiTIP by external partnerships/LLCs. Except as

described in the preceding sentence, individual investment decisions will be left to the general

partnership or LLC managers.


SECTION G PAGE | 2

G.2. Policy

A. Background

The Hawaii Targeted Investment Program (HiTIP) is a distinct component of the ERS private

equity portfolio. The ERS has established the HiTIP to participate in attractive long-term

alternative investment opportunities in emerging growth and growth-oriented businesses in

traded sector industries, emphasizing the greater-Hawai‘i geographic region. Investment of

moneys in the HiTIP will generally be implemented through participation in limited

partnerships or LLCs that make private equity and debt investments, including investments

in emerging growth and growth-oriented businesses, although other management and

investment arrangements may be considered under appropriate circumstances. For the

purposes of this policy:

"Emerging growth business" means a new or small company that has the capacity,

upon obtaining appropriate capital, to generate significant high skill, high wage

employment within one or more traded sector industries.

“Growth-oriented business” means an existing company with the potential to

generate significant revenue and/or profit growth within one or more traded sector

industries, resulting in a commensurate increase in high skill/wage employment in

the pertinent sectors.

“Traded sector” means industries in which member firms sell their goods or services

into markets for which national or international competition exists.

Chapter 88, Hawai‘i Revised Statutes (“HRS”), which governs ERS investment activities,

and this ERS Investment Policies, Guidelines and Procedures manual (“Manual”) will govern

investment the activity of the HiTIP.

B. General Policy

Private equity investments, such as those encompassed by the HiTIP, should contribute

favorably to the risk-adjusted investment returns of the total ERS investment portfolio, and

are compatible with the general objectives of the ERS investment portfolio, which include:

1. Providing a means to provide benefits to the State's public employees and their

beneficiaries.

2. Investing to produce a return on investment which, based on levels of liquidity and

investment risk, are prudent and reasonable.

3. Attaining an adequate real return over the expected rate of inflation.

4. Complying with all applicable laws and regulations concerning the investment of

trust fund assets.

Private equity investments possess a higher degree of risk with a higher return potential than

traditional investments. Accordingly, total rates of return are expected to be greater than

those that may be obtained from conventional public equity or debt investments. They have

a lower correlation relative to other investment classes and should therefore contribute to an

effective management of risk and the enhancement of returns on a total ERS portfolio basis.


SECTION G PAGE | 3

Similar to other portfolio segments under its authority, ERS should endeavor to retain

appropriate fiduciary expertise to manage all or a portion of the private equity portfolio,

including the HiTIP.

C. Objectives

1. Portfolio Investment Performance Objective

The performance objective for HiTIP investments is significant long-term net returns to

the ERS investment portfolio, (e.g., after management fees and general partner's carried

interest) above a benchmark reflecting public market alternatives or counterparts plus an

appropriate premium to compensate for illiquidity, risk, and expense. The return

expectation should be tempered, however, given the potential concentration of

investments within Hawai‘i. The performance objective for private equity investments

is a net internal rate of return (i.e., dollar-weighted rate of return) of: the MSCI ACWI

IMI ND Index plus 200 basis points, measured over the life of the partnership or LLC.

Staff will periodically evaluate the performance benchmark and associated premium. 1

In any case, results of such investments may not be meaningful for several years.

2. Diversification of HiTIP Investment Risks

Diversification helps to minimize risk in the HiTIP's investments and the following types

of diversification should be considered, including, but not limited to:

a) Stage -- Diversify investments throughout the various stages from early stage

through later stage financing.

b) Industry Sectors -- Investments will be diversified across industries, subject to

the investment opportunities and the discretion, within the parameters of the

partnership/LLC agreements, of the general partners/managers retained.

c) Size of Investments -- Investments will be diversified among a range of

partnerships/LLCs of varying sizes, generally with a minimum commitment size

of $1 million but with an ERS ownership percentage usually at or below one-

third of the total fund.

d) Geographical -- The HiTIP, by statute, will be biased toward Hawaiian

companies and/or concentrated within the State; this risk cannot be diversified

away and may be significant. While such a geographic bias is likely to exist,

there is a reasonable likelihood that the business mix of the underlying

companies could be global in nature, offsetting the above-referenced lack of

geographic diversification.

e) Time – The HiTIP will endeavor to invest in a consistent manner over time and

shall not seek to “time the market.”

3. Total Private Equity Portfolio Diversification

1 ERS changed the private equity benchmark from the Russell 3000 Index plus 350 basis points effective 10/1/2014.


SECTION G PAGE | 4

Correlation of the HiTIP's investment return to other private equity segments is expected

to be relatively low, and the inclusion of this component should, therefore, provide an

added measure of diversification to the broader ERS private equity program.

4. HiTIP Program Size – Prudent Level of Investment

Act 260, requires ERS to “develop criteria to determine the amount of funds that may be

prudently invested in Hawai‘i private placement investments.” To meet this

requirement, the ERS relied upon an independent third-party analysis of Hawai‘i private

equity investment trends, published in January 2008 by the Hawai‘i Institute for Public

Affairs (HIPA), a nonpartisan research institute focusing on key Hawaiian economic

trends. The analysis, entitled Venture Capital in Hawai‘i – An assessment of Market

Opportunities, proved to be a foundational study on private equity capital formation

within the State. Over the years, other reports have generally confirmed the findings of

the HIPA report.2

One important condition for any private equity program to deliver its expected return

objective is that the market(s) it serve(s) have an imbalance of supply and demand for

private equity capital. Specifically, if the expected amount of capital available for

investment is less than the expected amount of capital required, then a “funding gap” is

said to exist. Such a funding gap can cause investor capital to be marginally more

attractive, allowing investors to seek incrementally higher returns. The larger the

funding gap, the broader the investment choices and the lower the competition among

investors placing capital in the marketplace.

The HIPA report found that a modest private equity funding gap exists in Hawai‘i. Based

on a review of the report’s figures by the ERS’s general investment consultant (Pension

Consulting Alliance, Inc. – or PCA), the annual expected funding gap falls in a range of

~$5 million to ~$45 million. In order to increase the probability of the HiTIP’s

successfully meeting its objectives, PCA recommended to ERS that the HiTIP fund only

a fraction of the expected funding gap, to a maximum of 50%, to bring more flexibility

and higher returns to the program, and a minimum of 25%, to attract a sufficient number

of vendors to compete for the opportunity to manage a Hawai‘i-oriented private equity

program with a focus on venture capital and other growth-oriented opportunities.

2 See, for example, Hawaii Innovation Assets Report, 2015-2015, commissioned by the Hawaii Business Roundtable; #STARTUPPARADISE,

Stafford Capital Partners, June 2016.


SECTION G PAGE | 5

G.3. Procedures

A. Procedures and Standards

1. General Procedures

a) The Board, Investment Staff, and the ERS’s general investment consultant

(“General Investment Consultant”) will seek, identify, and screen appropriate

fund-of-funds advisors that exhibit (i) expertise in structuring successful long-

term targeted investment programs, (ii) sufficient resources to screen, analyze,

and conduct due diligence on a wide array of private equity partnerships (and/or

LLCs), and (iii) a willingness to commit significant resources to Hawai‘i-

focused private equity investment.

b) The Board, with assistance from the General Investment Consultant, will select

an appropriate advisor to execute the HiTIP investment program. Key aspects

of the program are (i) identifying partnerships or partnership groups (or LLCs)

that are focused on, emphasize, or have made material investment allocations to

the greater-Hawai‘i economy, (ii) developing a long-term investment strategy

and/or business plan that places high priority on committing material amounts

of capital to Hawai‘i businesses, and (iii) establishing and fostering a growing

private equity network within Hawai‘i.

c) The fund-of-funds advisor will identify promising investment vehicles and

conduct full due diligence (including legal due diligence) on prospective

investments. Upon completion of its due diligence, the fund-of-funds advisor

will evaluate the investment vehicle and determine whether the investment

should be pursued.

d) Direct investments into portfolio company co-investments are not allowed

without first making the appropriate changes to this policy.

e) Upon satisfactory due diligence and legal reviews, the fund-of-funds advisor

will, on behalf of the Board, authorize a commitment to a specific partnership,

LLC, where ERS holds an economic interest in a vehicle that is managed by a

general partner or managing member.

f) The fund-of-funds advisor will provide a written report to the Board containing

a summary of the approved investment vehicle as soon as practical. For fund

investments the summary may include: a description of the general

partner's/manager’s background, historical performance, and organization; the

proposed investment strategy; the terms of the investment; the expected rate of

return; the merits of the investment; issues and concerns surrounding the

investment and how they were resolved; and issues and provisions that were

subject to negotiation.

2. Selection Criteria – External General Partners/Managers

a) The HiTIP’s fund-of-funds advisor will generally invest with partnership (or

LLC) groups with prior investment management experience. Primary emphasis

will be on the quality and experience of the individuals who manage the

investments. It is expected that the fund-of-funds advisor will conduct sufficient


SECTION G PAGE | 6

due diligence to address and examine the criteria for selection outlined in this

section. The fund-of-funds advisor will provide a summary due diligence report

to Investment Staff for each partnership commitment.

b) Additional criteria to be considered shall include:

i. A well-developed investment focus that meets the HiTIP's objectives,

and a favorable assessment of the proposed investment's strategy and

market conditions;

ii. Relevant investment experience of partners/managers and key

staff, individually and as a team, as well as their stability;

iii. Organizational depth and significant time commitment to the

investment vehicle;

iv. Well-structured decision-making and transaction execution processes,

including:

deal flow and initial analysis of portfolio investments,

pricing, selection and negotiation of portfolio investments,

financial structuring of portfolio investments,

management or oversight of portfolio companies,

development of exit strategies;

v. Consideration of relevant issues, such as conflicts of interest and

alignment of interests, among others;

vi. Experience in, and a demonstrated record of, successful prior

investments;

vii. Appropriate proposed terms and structure for the investment.

viii. Meaningful capital commitments by the partners/managers.

3. Standards

a) Types of Allowable Investments – The applicable State statute (Section 88-119,

HRS) allows for a wide array of investment vehicles. ERS private equity

investment policies allow investments in limited partnership LLC vehicles

without prior Board approval.

b) Prudent Investor Standard -- The selection of HiTIP investment vehicles will be

guided by the care, skill and diligence that a prudent investor acting in a similar

capacity and familiar with such investments would use in managing and

investing a similar account. Investments should be expected to enhance the

expected risk-adjusted investment returns of the broader ERS investment

portfolio.

c) Negotiated Terms -- Terms, such as preferred returns, lower fee structures, and

profit splits should be negotiated where prudent, adhering to best practices

within the institutional investment community. All agreements are subject to the

satisfactory negotiation of terms by the fund-of-funds advisor.

B. Strategy

1. Allocation

The HiTIP will be selective and more focused than the current private equity program,

and invest such assets prudently, and as opportunities become available. Diversification


SECTION G PAGE | 7

within the HiTIP is a consideration, but is extremely limited given the intent of Act 260,

which is the primary impetus for HiTIP.

a) Allocation by Fund Type

An important component of the HiTIP investment strategy is to seek out and

invest in Hawai‘i-based opportunities. Access to such opportunities may occur

through (i) partnerships/LLCs that are headquartered in Hawai‘i or (ii)

partnerships/LLCs that are not located in Hawai‘i, but make investments in

Hawai‘i. One framework to categorize partnerships is as follows:

i. Partnerships/LLCs that are Hawai‘i focused – Those

partnerships/LLCs that invest 90% of their capital locally.

ii. Partnerships/LLCs that have a Hawai‘i presence – Those

partnerships/LLCs that have invested in at least two Hawai‘i-based

companies in their most recent funds and visit Hawai‘i on a regular

basis.

iii. Partnerships/LLCs that are occasional investors – Those

partnerships/LLCs that invested in Hawai‘i at least once across all

their funds.

Longer-term, the HiTIP seeks to achieve reasonable and prudent weightings

among the above fund types, with a clear emphasis on Hawaii-based

investments. More specifically, the fund-of-funds advisor has agreed to make

commitments so that 25% - 33% of investments will be directed toward Hawai’i

focused partnerships and the remaining 67% - 75% of investments will reside

with regional and/or national partnerships/LLCs that fall under the latter two

above categories., Significant concentration toward any of the above segments

can occur over time as a result of how and when opportunities become available

and because each HiTIP investment will likely not be fungible and/or exhibit

low levels of liquidity.

2. Method of Participation

The HiTIP will consider well-established investment vehicles as well as new and smaller

investment vehicles. To the extent possible, partnerships and/or LLCs shall be structured

to create an alignment of interest between the limited partners/passive investors and the

general partners/managing members.

3. Investment Funding

Partners/managers retained by the HiTIP shall make capital calls during agreed upon

investment periods in accordance with negotiated agreements. Such requests must be in

compliance with both fund-of-funds advisor and ERS internal control procedures.

4. Investment Liquidations

Partners/managers shall return capital to the HiTIP through cash distributions, whenever

possible. Partners/managers shall liquidate any marketable securities before making

distributions to the HiTIP. In instances where liquidation is not in the best interest of the

HiTIP, partners/managers may distribute securities with sufficient advance notice to the

fund-of-funds and Staff. ERS may utilize the fund-of-funds advisor or retain a third party


SECTION G PAGE | 8

manager to liquidate such securities as deemed appropriate by the third party manager,

generally, within a six-month period.

5. Declarations of Distribution From HiTIP

All investment returns on capital in the HiTIP, including but not limited to returns from

investments in limited partnerships/LLCs and interest income, shall remain in the HiTIP

account until such time as the Board, in accordance with this policy, declares them as

HiTIP distributions available for transfer from the HiTIP account and back to the overall

ERS investment portfolio. The Board will, from time to time, review the HiTIP’s

investment returns and determine whether a portion of those returns can be distributed to

other accounts without impairing the HiTIP account’s long-term goal of maximizing the

overall rate of return consistent with the HiTIP’s investment focus. In making this

determination, the Board will consider (1) the current and anticipated future expenses of

the HiTIP in carrying out its operations, (2) the existence and need for reserves in the

HiTIP account to cover current investment commitments, (3) the potential need to make

additional investments in current investment vehicles tomaximize the overall return from

those investment vehicles, (4) the existence (or anticipated future development) and

relative attractiveness of new investment opportunities and the availability of other

moneys in the HiTIP account for such investment opportunities, and (5) such other

factors as ERS and/or the fund-of-funds advisor may consider appropriate under the

current circumstances.

C. Implementation

1. Staff Requirements

Appropriate Investment Staff will be assigned as the workload necessitates. It is

expected that the retained fund-of-funds advisor will be responsible for much of the day-

to-day operations of the HiTIP. To gain further insights into the overall due diligence

process (particularly within the State), Investment Staff may conduct due diligence visits

in conjunction with, or separate from, the fund-of-funds advisor on specific investment

opportunities. Such visitations should not impact the advisor’s recommendations and

implementation activities.

2. Legal Counsel

The fund-of-funds advisor is responsible for obtaining all relevant legal advice for the

HiTIP investments.

3. Contract Execution

a) The Board will approve an overall multi-year commitment level to the fund-of-

funds advisor. The Board will give discretion to the fund-of-funds advisor,

acting as a fiduciary on behalf of the ERS, to conduct business, financial, and

legal due diligence on, and then approve commitments to, underlying

partnerships/LLCs.

b) The fund-of-funds advisor, as general partner or manager of the limited

partnership or LLC described in D.1, below, is authorized to execute contracts

for specific HiTIP investments, up to the total commitment level authorized by

the Board.


SECTION G PAGE | 9

4. Fund-of-Funds Advisor Contract

a) The fund-of-funds advisor contract shall be structured as a general

partner/limited partner agreement with a termination date not to exceed twelve

years, including extension periods.

b) The fund-of-funds agreement shall include a “no-cause” fund-of-funds

advisor/general partner replacement clause with a maximum 90 day notice

period.

c) It is the policy of the Board to continuously review all contracts.

d) Upon the expiration of the Fund-of-Funds Advisor’s contract, or whenever

directed by the Board, Investment Staff and/or General Investment Consultant

shall undertake and complete a search process which shall include the following:

iv. Identification of those potential fund-of-funds advisor candidates who

may reasonably be believed to perform those services under

examination;

v. Directing of a request for proposal which shall include, but not be

limited to:

1. description of services requested;

2. description of the potential or preliminary standards required

by the Board of the candidates; and,

3. request for pricing or fee schedule information.

D. Monitoring

1. Reports

a) Reports prepared by the HiTIP fund-of-funds advisor will be furnished to the

Board and Investment Staff, quarterly, on HiTIP activity and performance, and

annually in an expanded format.

b) Underlying general partners/managers shall provide semi-annual reports to the

fund-of-funds advisor and Investment Staff on investment activity and

performance. In addition, audited financial statements shall be provided on an

annual basis.

c) Section 88-119(11), HRS, requires that ERS report annually to the legislature on

HiTIP investment activity, as well as on any other ERS investments that are

located in Hawai‘i. As part of the reporting process, ERS is required to report

rationale for not investing in Hawai‘i venture capital investments.

2. Adherence to Strategy

The actual strategy employed by underlying general partners/managers will be judged

relative to stated objectives and strategies. Investment Staff and the fund-of-funds

advisor will interact with the general partners/managers periodically as necessary. It is

also expected that the fund-of-funds advisor and/or Investment Staff will also attend

advisory meetings, board meetings, and/or annual investor meetings of the underlying


SECTION G PAGE | 10

partnerships or LLCs, as required (particularly with respect to Hawai‘i-based

investments), as part of the monitoring process. Given the illiquid nature of these

investments, however, it is not anticipated that these investments can be exited once a

commitment is made.

E. Review and Modification of Investment Policy Statement

The Board may review this policy statement and procedures from time to time to determine

if the Board deems modifications to be necessary or desirable.


SECTION H

C R I S I S R I S K O F F S E T P R O G R A M

S E C T I O N: H


SECTION H

TABLE OF CONTENTS

Page

1. OVERVIEW ........................................................................................................................................... 1


B. PURPOSE ........................................................................................................................................ 2


2. CLASS STRUCTURE ........................................................................................................................... 3

A. LEGAL STRUCTURE .................................................................................................................... 3

B. COMPONENTS .............................................................................................................................. 3

C. MODIFICATIONS TO COMPONENT STRUCTURE ................................................................ 3

D. COMPONENTS’ ALLOCATIONS AND ALLOCATION RANGES ......................................... 4

E. MANAGEMENT OF COMPONENTS ......................................................................................... 4

F. COMPONENTS’ MANAGERS & MANAGERS’ ALLOCATIONS .......................................... 5




C. COMPONENT RISK PROFILE(S) ................................................................................................ 8


A. LONG DURATION MANAGERS ................................................................................................ 9

B. TREND FOLLOWING/CAPTURE MANAGERS ..................................................................... 10

C. ALTERNATIVE RISK PREMIA MANAGERS ......................................................................... 11

APPENDIX




SECTION H PAGE | 1

H.1. Overview


The Crisis Risk Offset (“CRO”) class is structured to invest in strategies and assets that are

largely exposed to systematic market-based and non-market-based risk premiums that are

expected to behave in a manner that is primarily distinct or counter to the equity risk

premium. Such investments are typically designed to exhibit volatility that is in-line with

the risk of the Broad Growth class. Having this level of volatility is important so that

during periods of Broad Growth stress, the CRO class can feasibly move by a similar extent

in the opposite direction. The CRO class consists of three major components: Treasury

Duration Capture (“TDC”), Systematic Trend Following (“STF”), and Alternative Return

Capture (“ARC”).

The TDC component consists of highly-liquid long-maturity cash bonds or equivalent

(derivatives-based) investments. This component has proven to be the most responsive to

equity-related market crises as global investors seek the highest-quality asset possible

during such periods. The TDC component could be viewed as the “first-responder” during

an equity-related crisis as it tends to appreciate significantly in a crisis’ initial phases.

The STF component consists of investment strategies that systematically seek to capture

trending market behavior (either positive or negative) across dozens, if not hundreds, of

different markets. Trends take time to form, but once they do, there is significant evidence

that shows positive returns can be generated by investing in persistent trends. In this

respect, STF strategies provide subsequent support/substitution to the TDC component

during the mid-to-latter stages of a market crisis. STF strategies also trade in highly-liquid,

transparent markets and the capital invested in such strategies is easily accessible.

The ARC component consists of investment strategies that systematically seek to capture

the long-term returns of certain well-known risk premiums (e.g., value, carry, momentum,

low-volatility, etc.) without being exposed to the broader markets where these risk premia

reside. Over time these various risk premia are expected to produce positive returns (just

like the well-known equity risk premium) that are generally unrelated to the other major

market risk premia (e.g., equity, interest rates, inflation, etc.). Markets and instruments

utilized by ARC strategies are also highly-liquid, but their capture requires significant

leverage.

Due to the need to capture certain risk premia and avoid other risk premia, both the STF

strategies and the ARC strategies rely heavily on the use of derivatives. In addition,

derivatives-based leverage is often utilized to calibrate the expected risk of these strategies

to the risk of the investments that these components are intended to protect against.


SECTION H PAGE | 2

B. Purpose

The total portfolio is expected to produce a positive long-term real (inflation-adjusted)

compound return. In order to achieve such a return, the total portfolio must accept

exposures to various major broad-based market risks, in particular risk that is associated

with exposure to economic growth. A major challenge is that economic growth and those

assets with the most exposure to capitalizing on economic growth (e.g., public equity) are

sensitive to uncertainty regarding levels and duration of economic growth, introducing

significant volatility into the return behavior of a diversified investment portfolio. And, as

is well-known, periods of significant depreciation (worse than -20%) in such growth-

related investments can occur, putting pressure on those parties that rely on the outcomes

of the total portfolio. By design, the CRO class seeks to produce significant increases in

value coincident with significant declines in the values of growth-risk exposed assets. This

return-offset feature is the CRO class’s primary purpose. Assuming the class fulfills this

objective, the return pattern of the overall portfolio will become more stable over time and

exhibit lower exposure to the dangers of bearing significant growth risk.

Given its crisis-period focus and its designed relatively high volatility, the CRO may

produce challenging performance of its own, particularly during non-crisis periods. The

non-TDC components (particularly ARC) are included to supplement the TDC component

during these periods while not necessarily relying upon economic growth to achieve

positive results. The expectation is that the CRO would produce a modest positive real

compound return during these more growth-accommodating periods.


Major

- Interest Rate Risk (due to Long Treasury Duration component)

- Inflation Risk

- Varying market-based risks based upon their trending behaviors

Minor

- Specific non-market systematic style risks (periodic)


SECTION H PAGE | 3

H.2. Class Structure

A. Legal Structure

The CRO class utilizes a series of Delaware LLC’s, one for each CRO investment manager,

to ensure transparency of the assets and transactions in each account, ensure the ability to

subscribe or redeem units daily, and limit liability. The exception to using an LLC is

Treasury Duration Capture portfolios, which may instead utilize a custody account.

B. Components

The CRO class consists of three major components: TDC, STF, and ARC.

Treasury Duration Capture

- Portfolios of long-dated (maturities in excess of 10 years) high-quality bonds

(Treasuries and Government-backed high-quality, very liquid agencies) that

can be sold in their entirety at market price within 24 to 48 hours.

- Portfolios of cash-collateralized derivatives that mirror the performance of

long-dated high-quality bonds and maintain the TDC duration/volatility

targets.

Systematic Trend Following

- Long-short portfolios utilizing both cash and derivatives-based instruments to

capture both periodic appreciation and periodic depreciation trends that evolve

and dissipate across a very wide array of liquid global markets. Risk/volatility

is calibrated to a pre-determined level utilizing cash and derivatives-based

leverage.

Alternative Return Capture

- Long-short portfolios utilizing both cash and derivatives-based instruments to

capture well-researched/documented non-market risk premiums (e.g.,

momentum, carry, value, low-volatility, etc.) on a continuous basis, utilizing

an array of liquid global markets. Risk/volatility is calibrated to a pre-

determined level utilizing cash and derivatives-based leverage.

C. Modifications to Class/Component Structure

Modifications to the CRO class’s structure can take five potential forms:

i. Changing the legal structure;


iii. Revising allocation levels and ranges among the components;

iv. Adjusting the breadth of investment strategies utilized within each component;

v. Possible use of internal management for the TDC portfolio.

Modifications to the CRO’s structure will occur only with approval of the Board of Trustees.


SECTION H PAGE | 4

D. Components’ Allocations and Allocation Ranges

The CRO class’s allocation targets and allocation ranges among its three major components

are as follows (as a percent of total CRO class assets):

Long-term CRO Class Component Allocation Policy*

Component Lower Limit Upper Limit

Treasury Duration Capture 20% 30%

Systematic Trend Following 30% 40%

Alternative Return Capture 35% 45%

*Capital allocations are a function of the underlying risks of each component (see Sections I.3.B. and

I.3.C. below). The allocation structure above translates to an expected annualized volatility of

≈11%, which is close to the expected volatility of the ERS’s public growth portfolio over a market

cycle. Allocations within the above ranges should generally adhere to the Board-approved structure.

E. Management of Components

To manage the assets assigned to the CRO class components, the Board of Trustees

(“Board of Trustees” or “Board”) of the Employees’ Retirement System of the State of

Hawaii (“ERS”) utilizes external investment managers (“investment managers”), a CRO

Platform Manager, ERS investment staff, and the ERS General Consultant.

Each investment manager is responsible for executing the particular investment strategy

(i.e., mandate) that the ERS has hired them to manage. Investment managers perform all

of the typical investment functions expected for separately managed accounts with the

addition of daily oversight by the CRO Platform Manager.

The CRO Platform Manager, acting as a fiduciary to the ERS, is responsible for

establishing the managed account structure and service provider relationships; serving as

manager of the LLC’s; overseeing the day-to-day operations of the CRO class,

components, managed accounts and managers, including measuring market risk, enforcing

compliance to CRO policies, procedures, limits and guidelines as well as systematically

rebalancing the accounts utilizing the rebalancing rules established in the CRO Procedures

Manual; helping to identify crisis situations; conducting annual manager operational due

diligence; and communicating with and advising the ERS investment staff on

investment/risk guidelines.

The ERS investment staff, and in particular the ERS CRO Manager designated by the ERS

CIO, is responsible for evaluating and recommending investment managers and CRO

Platform Manager candidates to the ERS Board, conducting onsite investment manager (at

least biannually) and CRO Platform Manager (annually) due diligence, monitoring the

CRO class on a daily basis, allocating capital to and adjusting risk targets for CRO

components and investment managers, creating and maintaining the CRO Procedures

Manual, adjusting investment and risk guidelines/limits, establishing the CRO rebalancing

rules, and reporting class level risk/return metrics to the ERS Board on a quarterly basis.

The ERS CIO is responsible for monitoring the CRO class on a weekly basis and

determining the response to crisis situations.


SECTION H PAGE | 5

The General Consultant is responsible for monitoring the CRO class on a monthly basis,

advising the ERS CRO Manager and CIO on CRO policy, procedures, limits and

guidelines, assisting the ERS investment staff in its due diligence and oversight

responsibilities, and providing quarterly/annual evaluations of the CRO class to the ERS

Board.

The ERS Board is responsible for approving this CRO Policy; approving the CRO

structure; approving the CRO investment managers; delegating responsibilities to the ERS

investment staff, CRO Platform Manager, General Consultant, and CRO investment

managers; and periodically reviewing the performance and risk profile of the CRO class,

components, and managers.

Within each component, assets are expected to be allocated across one or more mandate(s).

In combination, these mandates capture a broad, representative sampling of the available

investment opportunity set within the specified component. The mandate allocations

within each component are as follows:

Treasury Duration Capture Component Allocation Policy

Passive/Replication 0% - 100%

Active 0% - 100%

Systematic Trend Following Component Allocation Policy

Passive/Replication 0% - 50%

Active 0% - 100%

Alternative Return Capture Component Allocation Policy

Passive/Replication 0%

Active 100%

F. CRO Component’s Managers and Managers’ Allocations


Board delegates investment authority to external investment managers. The ERS’s General

Consultant and investment staff have joint authority for identifying and selecting

investment manager candidates for specific investment mandates. The Board has final

authority over the selection of specific managers for each mandate. ERS investment staff

has the authority to determine the initial funding level for each investment manager

approved by the ERS Board and manage the allocation to each investment manager on an

ongoing basis. Under this authority, ERS investment staff may reduce funding to one or

more specific manager(s) and/or increase funding to one or more specific manager(s) as

long as the risk profile of each component is maintained. The investment manager

allocations within each component are as follows:


SECTION H PAGE | 6

Treasury Duration Capture Component Manager Allocation Policy

Active Managers: 0% - 100% per manager.

Up to two managers approved by the Board may be funded.

Systematic Trend Following Component Manager Allocation Policy

Active Managers:

Passive/Replication Managers:

0% - 50% per manager.

0% - 50% per manager.

Up to five managers approved by the Board may

be funded.

Alternative Return Capture Component Manager Allocation Policy

Active Managers: 0% - 50% per manager.

Up to four managers approved by the Board may be funded.

H.3. Return Objectives & Risk Profile


Within the CRO class, the standards for component performance reporting may vary.

Keeping this in mind, the ERS utilizes the target benchmark below to monitor the

performance results of the aggregate CRO class:

25% Barclays Capital U.S. Treasury Long Index +

35% MLM Global Index (15% Vol)* +

40% (90 Day Treasury Bills + 2.5%/year)

*The MLM Global Index (15% Vol) is the Mount Lucas Management Enhanced Volatility (MLM-

EV) Index with the addition of an allocation to equity index derivatives. Through the use of

derivative-based leverage, the MLM Global Index (15% Volatility) is leveraged approximately 3X

the equivalent fully-collateralized index in order to calibrate its expected volatility to a level that is

similar to the volatility exhibited by the MSCI ACWI benchmark.

The CRO class portfolio is expected to match or outperform the above benchmark, net of

fees, over a full market cycle. An appropriate measure of a market cycle would be rolling

5-year periods. The CRO class portfolio should outperform its benchmark, net of fees,

over the majority of rolling 5-year periods. The ERS CRO Manager, in consultation with

the CRO Platform Manager and General Consultant, will establish an appropriate volatility

benchmark composed of investable indices to compare to the CRO realized volatility.

The Treasury Duration Capture component portfolio is expected to outperform the

following target benchmark, net of fees, over the majority of rolling 5-year periods:

Barclays Capital U.S. Treasury Long Index


SECTION H PAGE | 7

The Systematic Trend Following component portfolio is expected to outperform the


MLM Global Index EV (15% Vol)

The Alternative Return Capture component portfolio is expected to outperform the


90-Day Treasury Bills + 2.5%/year

B. Class Risk and Return Profile

In aggregate, the CRO is designed to be an offsetting class that hedges against large

declines in growth-exposed assets (e.g., public equity and credit) during severe bear

market/crisis periods. Based on current capital market assumptions and the CRO class’s

long-term structure, there is a low probability that this class could lose a portion of its

capital over a 10-year period. While not producing the bulk of the ERS Plan’s expected

investment returns, the CRO class is positioned to provide positive nominal returns and

opportunities to reallocate capital to undervalued assets over the long-term. This class is

meant to meaningfully complement the high volatility associated with the ERS public

growth portfolio, while providing a level of return moderately above the ERS Principal

Protection class. A strategic allocation to the CRO class should provide an improved level

of diversification for the total portfolio. The class may be negatively impacted by periods

of rapid economic growth, significant inflation, rapid shifts in correlations among asset

class and/or periods of volatile markets without sustained trends.

The aggregate CRO class has a total risk (standard deviation) range/budget in order to

effectively counterbalance the volatility experienced in the ERS’s major growth-oriented

components. There is also a value-at-risk limit (one day CRO NAV loss at a 5%

probability) established by the ERS CRO Manager in consultation with the CRO Platform

Manager and General Consultant to ensure that downside CRO risk is contained. These

limits are provided below.

CRO Class Absolute Risk Level Maintenance Policy

Measure Lower Risk Limit Upper Risk Limit

Annualized Volatility

Value at Risk (5%)

8%

n/a

18%

<=2.0%

If the behavior of the CRO class causes its recent historical volatility to deviate

significantly beyond these limits, then a rebalancing process and/or target volatility

adjustment should occur among the CRO managers based on recent risk profiles of each

manager/component as well as on prospective risk views for each manager/component.


SECTION H PAGE | 8


The ERS is expected to manage the Treasury Duration Capture component portfolio by

taking active risk (tracking error) around its benchmark discussed under Section I.3.A.

above. Active risk within a specific component portfolio is the aggregation of several risks

taken/accepted by ERS investment staff and/or the CRO investment manager(s) as they

implement the component portfolios. Types of active risk include: security selection risk,

sector/style bias risk, manager weighting risk, and benchmark misfit risk. The expected

volatility and allowable active risk ranges for the Treasury Duration Capture component

are shown in the table below. These risk budgets may be further restricted by the ERS

CRO Manager in the CRO Procedures Manual and in the investment management

agreements (“IMAs”) for each CRO investment manager.

Risk Budget: Volatility & Tracking Error Ranges (% Net Asset Value)

Component Annualized Volatility

Expectation

Allowable Tracking

Error

Treasury Duration Capture 8% - 18% <= 3.0%/year

The ERS is expected to manage the Systematic Trend Following and Alternative Return

Capture component portfolios by stipulating a target for annualized volatility (i.e.,

annualized standard deviation) and a maximum value-at-risk limit for a one-day net asset

value loss at a 5% confidence level (“VaR (5%)”) for each investment manager. The VaR

threshold is the total daily loss amount that the daily return is expected to exceed on only

5% of trading days. It is typically based on the expected volatility of a portfolio.

The maximum drawdown threshold is based on a 5% confidence level for a loss of net

asset value over a one-year horizon; at the CRO component level, this limit is only expected

to be exceeded one year out of 20 years. Given that each CRO component’s volatility must

be large enough to offset equity volatility, maximum drawdown limits at the individual

manager level can be sizable. Overall drawdown risk within a specific component portfolio

is the aggregation of several drawdown risks accepted by ERS’s investment managers as

they implement their mandates. Key factors driving drawdown risk include: leverage

level, position concentration, and correlations among risk premiums during market stress

periods.

The allowable target volatility range, value-at-risk limit, and maximum drawdown limit

for the Systematic Trend Following and Alternative Return Capture components are

provided in the table below. These risk budgets may be further restricted by the ERS CRO

Manager in the CRO Procedures Manual and extended to the investment management

agreements for each CRO investment manager.

Risk Budgets – Key CRO Components (% Net Asset Value)

Component Annualized

Volatility Range

VaR (5%)

Limit

Maximum

Drawdown Limit

Systematic Trend Following 10% - 20% 2.0% -25%

Alternative Return Capture 8% - 18% 2.0% -20%


SECTION H PAGE | 9

H.4. Manager Investment Guidelines

All investments and investment managers are subject to Section 88-119 (Investments), Hawai‘i

Revised Statutes, the Derivatives Policy in the Appendix of this section, and the following

guidelines. Only the Treasury Duration Capture managers are subject to the Watch Criteria in the

Appendix of this section. The ERS CRO Manager, in consultation with the CRO Platform Manager

and ERS CIO, may further restrict these guidelines or add guidelines for an investment manager to

control risks particular to that manager’s style.

A. Treasury Duration Capture Manager Guidelines

Approved Manager(s): Ryan Labs Asset Management, Inc.

Blackrock Financial Management, Inc. (Alternate) All allowable securities are described in Section 88-119 (Investments), HRS, the


Component: Treasury Duration Capture

Benchmark: Barclays Capital U.S. Treasury Long Index

Max. Tracking Error Objective: 3.0% Annualized (applies only to Enhanced Index Strategy) Refer to appendix for Watch Criteria and Return Expectations

Volatility Range: 8% - 18% expected annualized standard deviation


- The maximum gross leverage (the sum of the absolute values of the long

and short notional positions) constraint will be addressed in each

manager’s IMA.

- Acceptable Securities: Only cash, U.S. Treasury and Agency securities,

and exchange-traded Treasury futures are allowed.

- Specific security-type limits (as % of account net asset value):

o U.S. Government Agency MBS Max. 10%

o U.S. Government Agency Max. 20%

o U.S. Treasuries (including futures) Min. 80%

o Non-Benchmark Max. 20%

- Prohibited Securities: All non-U.S. Treasury/Agency instruments.

Duration Range: - Enhanced Index Strategy: +/-10% of the duration of the Benchmark.


SECTION H PAGE | 10

B. Systematic Trend Following Manager Guidelines

Approved Manager(s):

Aspect Capital Limited

Campbell & Company, Inc.

Crabel Capital Management, LLC

Alpha Simplex Group, LLC

Mount Lucas Management, LP (Replication)

Credit Suisse Asset Management, LLC (Alternate) All allowable securities are described in Section 88-119 (Investments), HRS, the


Component: Systematic Trend Following

Benchmark: MLM Global Index EV (18% Vol)

Target Volatility Objective: 15% to 20% annualized standard deviation with specific target determined

by ERS CRO Manager.

Value at Risk VaR limits will be addressed in each manager’s IMA.

Performance Objective: Outperform the MLM Global Index EV (18% Vol) over rolling 5-year

periods.

Maximum Drawdown Limit: 1.5x Target Volatility


- Cash collateral will be invested only in high quality short-term (<1

years) money market/fixed income investments, including cash.

- Derivatives will be utilized to establish numerous long and short

positions in a wide array of global markets (see Derivatives Policy in

CRO Policy Appendix).

- All investments will be in highly liquid securities and of such size that

they can be liquidated/closed at full market value (i.e., a value essentially

equivalent to the most recent reported value) within two trading days.

- Acceptable Securities: Exchange-traded futures, currency forwards and

futures, total return swaps on highly liquid equity securities,

currency/spot FX (cash), high quality/liquid money market and fixed

income instruments; all investments must be consistent with 88-119.

- Prohibited Securities: Any instrument not listed as an Acceptable

Security.

.


SECTION H PAGE | 11

C. Alternative Return Capture Manager Guidelines

Approved Manager(s):

ARP Americas, LP

Graham Capital Management, L.P.

Lombard Odier Asset Management (USA) Corporation

P/E Global LLC

Mellon Capital Management Corporation (Alternate)

Schroders Investment Management North America, Inc (Altern.) All allowable securities are described in Section 88-119 (Investments), HRS, the


Component: Alternative Return Capture

Benchmark: 90-Day Treasury Bills + 2.5%/year

Volatility Objective 10% - 20% annualized standard deviation with specific target determined by

ERS CRO Manager.

Value at Risk VaR limits will be addressed in each manager’s IMA.

Market Correlation Objective <0.30 correlation to public portion of ERS Broad Growth class over rolling

24-month periods.

Performance Objective Outperform the Benchmark over rolling 5-year periods.

Maximum Drawdown Limit 1.5x Target Volatility


- Cash collateral will be invested only in high quality short-term (<1

years) money market/fixed income investments, including cash.

- Derivatives will be utilized to establish numerous long and short

positions in a wide array of global markets (see Derivatives Policy in

CRO Policy Appendix).

- All investments will be in highly liquid securities and of such size that

they can be liquidated/closed at full market value (i.e., a value essentially

equivalent to the most recent reported value) within two trading days.

- Acceptable Securities: Exchange-traded futures, currency forwards and

futures, credit index default swaps, total return swaps on highly liquid

equity securities, currency/spot FX (cash), high quality/liquid money

market and fixed income instruments; all investments must be consistent

with 88-119.

- Prohibited Securities: Any instrument not listed as an Acceptable

Security.


SECTION H PAGE | 12

C R I S I S R I S K O F F S E T : A P P E N D I X


SECTION H PAGE | 13

Derivatives Policy for CRO Class

Derivatives may be used in the CRO portfolio to access the risk premia inherent to the mandates comprising

the CRO component portfolios; they may also be used as a substitute for a cash market security, risk control,

income, cost reduction, or liquidity management. Derivatives are not permitted for purposes of speculation.

Any derivative investment not explicitly authorized below is prohibited.

Where derivatives are used as substitutes for a specific cash security or set of cash securities, the

return volatility of the combination of the derivative and associated cash position shall be equivalent

to the unleveraged cash security or securities underlying the derivative instrument.

The Administrator for each CRO account shall mark-to-market their derivative positions daily.


Futures – commodity futures, equity index futures, bond futures, money market futures, and

currency futures where the manager has the authority to invest in the underlying or deliverable

cash market security. No physical delivery can be taken in commodity futures.

Currency forwards & spot FX.

Equity basket swaps (total return swaps on individual equity securities, both long and short).

Credit index default swaps

Futures contracts must be CTFC (Commodity Futures Trading Commission) approved and

exchange traded.

All trading counterparties must be approved by the CRO Platform Manager and be rated investment

grade as determined by at least one major rating agency.

Cross-hedging is permitted.

On a daily basis, the CRO Platform Manager shall examine all derivatives purchases of each CRO

investment manager for prohibited derivatives. Should any prohibited derivatives be found, the

Platform Manager should promptly notify ERS investment staff and instruct the investment manager

to sell the prohibited derivatives.


SECTION H PAGE | 14

0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00%

Watch Threshold -0.41% -0.82% -1.23% -1.63% -2.04% -2.45% -2.86% -3.27% -3.68% -4.08%


Watch Threshol -0.17% -0.33% -0.50% -0.67% -0.85% -1.02% -1.20% -1.38% -1.55% -1.73%


Watch Threshold 0.995 0.991 0.986 0.981 0.976 0.971 0.966 0.961 0.956 0.951


5.50% 6.00% 6.50% 7.00% 7.50% 8.00% 8.50% 9.00% 9.50% 10.00%

Watch Threshold -4.49% -4.90% -5.31% -5.72% -6.13% -6.53% -6.94% -7.35% -7.76% -8.17%


Watch Threshol -1.92% -2.10% -2.29% -2.47% -2.66% -2.85% -3.04% -3.24% -3.43% -3.63%


Watch Threshold 0.946 0.940 0.935 0.929 0.924 0.918 0.912 0.907 0.901 0.895


Long-Term

(5-year)

Short-Term

(1-year)

Medium-Term

(3-year)

Long-Term

(5-year)

Tracking Error

Tracking Error

Short-Term

(1-year)

Medium-Term

(3-year)

Treasury Duration Capture Manager Watch Criteria and Implied Excess Returns (annualized)

Short-Term Criteria (for TDC mandates):


Medium-Term Criteria (for TDC mandates):


Long-Term Criteria (for TDC mandates):




Rationale:





between 0.3 and 0.4, and was approximately 0.33 over the last 40 years. Intuitively then, if an uncorrelated

active strategy could be isolated, it should be expected to contribute at this level of return to volatility in

order to be additive to portfolio return to risk.







SECTION I

O P P O R T U N I T I E S P R O G R A M

S E C T I O N: I


SECTION I

TABLE OF CONTENTS

Page

1. OVERVIEW ........................................................................................................................................... 1


B. PURPOSE ........................................................................................................................................ 1


2. CLASS STRUCTURE ........................................................................................................................... 2

A. OVERVIEW .................................................................................................................................... 2

B. CHANGES TO CLASS STRUCTURE .......................................................................................... 2

C. OPPORTUNITIES CLASS MANAGERS AND MANAGERS’ ALLOCATIONS .................... 2

3. RETURN OBJECTIVES ....................................................................................................................... 3

A. BENCHMARKS FOR INDIVIDUAL MANDATES .................................................................... 3

B. BENCHMARKS FOR THE AGGREGATE CLASS .................................................................... 3


APPENDIX

DERIVATIVES POLICY ............................................................................................................... 6

WATCH CRITERIA AND IMPLIED EXCESS RETURNS ........................................................ 7


SECTION I PAGE | 1

I.1. Overview


The Opportunities class is established to invest in strategies that are not currently included

in the strategic policy portfolio but which have the potential to improve overall investment

results over time. It is expected that such investments must eventually mature, be

liquidated, or graduate out of the Opportunities class to one of ERS’s strategic classes. Key

characteristics of opportunistic investments might include: being significantly

undervalued due to market dislocations, high potential expected returns due to unique time-

specific opportunities, special opportunities presented to the ERS given its unique standing

in the investment marketplace, etc.

The Opportunities class will have a policy target allocation of 0%. It will be allowed to

vary between 0% and 3% of Total Portfolio assets. The 0% policy target is indicative of

the transitory nature of investments in the Opportunities class. In this respect, when there

are no compelling opportunities, or it is impractical to implement such opportunities, it is

expected that the Opportunities class would have an actual allocation very near, or equal

to, 0%.

B. Purpose

The Opportunities class provides the ERS a means to pursue unique investment

opportunities that do not fit into its strategic policy portfolio. Such investments often

involve transitory time-sensitive market opportunities. Given these features, funds

invested in the Opportunities class are expected to range widely. In fact, due to the

transitory nature of these investments, there may be periods when the class contains no

strategies or vehicles.


Due to the significant variation of strategies expected to flow through the Opportunities

class, risk factor exposures are also expected to fluctuate significantly.

Major Exposures (time varying)

- Growth Risk


- Liquidity Risk

- Idiosyncratic Risks

Minor

- Inflation Risk


SECTION I PAGE | 2

I.2. Class Structure

A. Overview

By definition, the Opportunities class will be an aggregation of individually unique

investment opportunities, each focused on exploiting a specific market environment or

investment idea. As a result, the structure of the class can and will likely be highly variable,

ranging from high concentrations of risk factor exposures to a reasonable range of risk

diversification. The characteristics of the Opportunities class will fallout from specific

investments made and held at a specific time. Unlike the ERS’s other major strategic

classes, there is no intention to manage the overall Opportunities class to a pre-defined set

of risk parameters/characteristics.

B. Changes to Class Structure

Changes to class structure will be driven by bottom-up investment allocations. There is no

pre-established structure to the Opportunities class. Structural changes within this class

can evolve in a dramatic fashion, given the size, timing, and quantity of investments made

within the class.

C. Opportunities Class Managers’ Selection and Managers’ Allocations

To manage the assets allocated to the Opportunities class, the Board will delegate

investment authority to external investment managers. The ERS’s investment consultants

and Investment Staff have joint authority for identifying specific investment opportunities,

determining the allocation amount, selecting investment manager candidates, and

recommending specific managers for specific investment mandates within the class. The

Board has the final authority to approve or disapprove the specific managers recommended

for each mandate. Investment Staff has the authority to manage the allocation to each

investment manager after the initial allocations are made.


SECTION I PAGE | 3

I.3. Return Objectives

A. Benchmarks for Individual Mandates

Each mandate within the Opportunities class will have a specific performance benchmark.

Since the mandates can vary widely (e.g., utilize public markets, private markets, or be a

hybrid of both types of markets; be sector-specific; etc.), specific benchmarks are also

likely to vary widely. Where possible, a specific performance benchmark will closely

match the mandate’s opportunity set of investments.

B. Benchmarks for the Aggregate Class

The overall benchmark for the Opportunities class is the market value weight of the

underlying benchmarks. The difference between this weighted benchmark and the actual

results of the Opportunities class will help determine the implementation success of the

overall Opportunities Program. Long-term returns from the Opportunities class should

match or exceed ERS’ total fund performance benchmark. This difference provides an

assessment of whether the Opportunities class is providing added value to ERS’s overall

investment program.


SECTION I PAGE | 4

I.4. Manager Investment Guidelines


Revised Statutes, the Derivatives Policy and Watch Criteria in the Appendix of this section. Each

manager and its mandate within the Opportunities Program will be assigned investment guidelines

comparable to those utilized in ERS’ other investment programs.


SECTION I PAGE | 5

O P P O R T U N I T I E S C L A S S : A P P E N D I X


SECTION I PAGE | 6

Derivatives Policy for the Opportunities Class







The notional value of the derivatives positions will likely exceed the total value of the underlying

capital assigned to the mandate.



Futures – equity index futures, bond futures, money market futures, and currency futures where

the manager has the authority to invest in the underlying or deliverable cash market security.





market instrument.


traded.

Options must be exchange traded .


Counterparties to OTC traded instruments (forwards) must be rated investment grade (A-) or better as

determined by at least one major rating agency.

Cross-hedging is permitted. The counterparties for foreign currency derivatives must be rated A- or

equivalent.










SECTION I PAGE | 7

0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00%

Watch Threshold -0.41% -0.82% -1.23% -1.63% -2.04% -2.45% -2.86% -3.27% -3.68% -4.08%


Watch Threshol -0.17% -0.33% -0.50% -0.67% -0.85% -1.02% -1.20% -1.38% -1.55% -1.73%


Watch Threshold 0.995 0.991 0.986 0.981 0.976 0.971 0.966 0.961 0.956 0.951


5.50% 6.00% 6.50% 7.00% 7.50% 8.00% 8.50% 9.00% 9.50% 10.00%

Watch Threshold -4.49% -4.90% -5.31% -5.72% -6.13% -6.53% -6.94% -7.35% -7.76% -8.17%


Watch Threshol -1.92% -2.10% -2.29% -2.47% -2.66% -2.85% -3.04% -3.24% -3.43% -3.63%


Watch Threshold 0.946 0.940 0.935 0.929 0.924 0.918 0.912 0.907 0.901 0.895


Long-Term

(5-year)

Short-Term

(1-year)

Medium-Term

(3-year)

Long-Term

(5-year)

Tracking Error

Tracking Error

Short-Term

(1-year)

Medium-Term

(3-year)


Short-Term Criteria (public market mandates):


Medium-Term Criteria (public market mandates):


Long-Term Criteria (public market mandates):




Rationale:













Watch-related criteria for private market mandates will be determined at time of retention.


SECTION J

IMPLEMENTATION OVERLAY PROGRAM

S E C T I O N: J


SECTION J

TABLE OF CONTENTS

Page

1. OVERVIEW ........................................................................................................................................... 1


B. PURPOSE ........................................................................................................................................ 1


2. PROGRAM STRUCTURE .................................................................................................................... 2

A. OVERVIEW .................................................................................................................................... 2

B. CHANGES TO PROGRAM STRUCTURE .................................................................................. 2

3. RETURN BENCHMARKS ................................................................................................................... 2


5. DERIVATIVES POLICY ...................................................................................................................... 5


SECTION J PAGE | 1

J.1. Overview


Overlay mandates are inherently custom by design. The objectives, roles, and guidelines for an

overlay manager can differ immensely from mandate to mandate. For the ERS, due to its fairly

unique portfolio structure, it is critical for the overlay manager to understand the ERS’s investment

objectives and portfolio structure, to have processes and systems in place to measure exposures on

a daily basis, to efficiently place trades to replicate desired exposures and hedge unwanted

exposures, and to provide robust reports to the ERS on a daily, monthly and quarterly basis.

The overlay is designed to improve the efficiency and performance of the Total Portfolio by

avoiding certain cash-drag and market-timing impacts that stem from paying benefits, receiving

employer/employee contributions, making private markets funds’ contributions and receiving

distributions, and other cashflow related activities. While the main role of such a manager will be

to equitize this frictional cash (i.e., invest cash balances in an efficient manner to replicate the Total

Portfolio), there are additional services that the overly manager may implement if requested by

ERS Investment Staff. Examples of these services include assisting the ERS Investment Staff with

portfolio rebalancing, asset allocation tilts, transitions, and hedging unwanted risks or exposures,

among others. The overlay manager will take responsibility for the funds that currently reside in

the ERS cash operating account, which typically has one to two percent of total ERS assets in cash,

plus an additional amount of funds to efficiently manage the cashflows from private markets

investments, benefits payments and employee/employer contributions. Cash in this new overlay

account will vary over time so that cash can be paid and received without affecting capital deployed

elsewhere in the portfolio, but is expected to be between one and four percent of total ERS assets.

Since the overlay account may contain only a portion of the un-invested cash being equitized and

the account may be creating desired exposures or hedging unwanted exposures that exist in the

ERS portfolio outside of the overlay account, the derivatives in the account may create liabilities

that exceed the value of the overlay account.

B. Purpose

A portfolio implementation overlay is a completely transparent and liquid investment account that

utilizes exchange-traded derivatives, currency forward rate agreements, and securities to:

1. Securitize un-invested cash to reduce performance drag,

2. Bridge exposure gaps related to manager transitions and portfolio reallocation to reduce

unwanted tracking error,

3. Passively rebalance the portfolio back towards policy targets without the need to disturb

investment managers, thereby reducing transaction costs,

4. Within pre-established policy ranges, tilt the capital allocations to express a market view,

5. Hedge such unwanted risks as foreign currency exposure, and

6. Better manage factor exposures to reduce unrewarded factors and increase rewarded factors.

The ERS overlay manager will initially focus on the first four purposes listed above.


SECTION J PAGE | 2


Due to the dynamic nature of an overlay program, risk factor exposures are also expected to

fluctuate significantly over time.

Major Exposures

- Growth Risk


- Currency Risk

Minor

- Inflation Risk

J.2. Program Structure

A. Overview

ERS Staff will retain full responsibility for making decisions related to establishing the benchmarks

for securitizing cash, permissible derivatives contracts, rebalancing, tilting the portfolio, and

hedging. The overlay manager will execute the overlay program on a daily basis by accessing

portfolio data from the ERS custodian to measure current exposures and un-invested cash levels

using a systematic methodology agreed upon in advance with ERS Staff to make the appropriate

trades. A proxy methodology may be used to approximate the value of portfolio assets that are

reported on a lagged basis. The overlay account will utilize a futures commission merchant (FCM)

as an agent and other executing futures brokers who are responsible solely for the execution,

clearing and/or carrying futures contracts and options on futures. As such, the overlay manager

will authorize the custodian to provide initial and variation margin to the FCM as required in the

Futures and Options on Futures Account Agreement that the ERS signs with the FCM. The overlay

manager will prepare daily, monthly and quarterly reports for ERS Staff detailing positions, trades,

return attribution and risk metrics. The overlay manager and ERS Staff will monitor the risk and

return of the overlay on an ongoing basis to ensure that it is performing according to expectations

and within risk tolerances.

B. Changes to Class Structure

ERS Staff will consult with the General Consultant and notify the Board before any material

changes to the structure or purposes are implemented.

J.3. Return Objectives

Benchmarks for Overlay Program

Cash securitization positions and the overlay program as a whole will utilize the Total Portfolio

benchmark net of the illiquidity premia for private market investments, but gross of fees. Positions

held for other approved purposes will not be benchmarked, but are expected to return at least the

3-month LIBOR rate for the capital they utilize. The overlay manager will be evaluated on how

effectively (both cost and execution) the program is implemented versus the targeted exposures.


SECTION J PAGE | 3

J.4. Overlay Manager Guidelines


Revised Statutes, the Derivatives Policy and Watch Criteria in the Appendix of this section.

Approved Manager: Parametric Portfolio Associates LLC



Overlay Benchmark: Total Portfolio Benchmark less liquidity premia

Overlay Performance Objective: Match the Benchmark gross of fees over rolling 5-year periods

Cash Collateral:

- Cash collateral will be invested only in high quality short-term

(<1 year) money market/fixed income investments, including

cash and cash sweep vehicles.

Security

Allowances/Restrictions:

- Derivatives will be utilized to establish long and short positions

in a wide array of global markets (see Derivatives Policy in

Overlay Policy Appendix).

- All investments will be in highly liquid securities and of such size

that they can be liquidated/closed at full market value (i.e., a value

essentially equivalent to the most recent reported value) within

two trading days.

Acceptable Securities:

Domestic and international equity index futures

Domestic and international fixed income futures

Foreign currency futures, forwards, and physical holdings

Commodity futures

Domestic and international equities

Exchange Traded Funds (ETFs) and Exchange Traded Notes

(ETNs)

Exchange Traded Options on Equities, ETFs and indexes

U.S. Government/Agency Securities (bills, notes, bonds)

Total return swap types pre-approved by ERS Staff

- All investments must be consistent with 88-119.

Prohibited Securities:

Any instrument not listed as an Acceptable Security.

Reporting Requirements:

Daily tracking report summarizing the ERS’s allocations,

manager values, overlay positions, and other key Investment

Strategy parameters

Quarterly performance summary reports describing the

performance of the strategies employed for ERS Staff & Board

Monthly and quarterly accounting reports reconciled to

Custodian’s statement

At least quarterly performance meetings/calls with ERS Staff


SECTION J PAGE | 4

IMPLEMENTATION OVERLAY: APPENDIX


SECTION J PAGE | 5

Derivatives Policy for Implementation Overlay Program

Derivatives may be used in the overlay account to access the market exposures of the overlay

mandate. Derivatives are not permitted for purposes of speculation. Any derivative investment

not explicitly authorized below is prohibited.

The notional value of the derivatives positions will likely exceed the total value of the

underlying capital assigned to the mandate.

The overlay manager must mark-to-market their derivative positions daily.

Permitted Derivative Instruments:

Futures – commodity futures, equity index futures, bond futures, money market

futures, and currency futures – only types that are pre-approved by ERS Staff are

permitted. No physical delivery can be taken in commodity futures.

Options – options on indices, ETFs, and bonds (including interest rate caps and

floors). Options on futures, swaps, and currencies are allowed if overlay manager has

permission to invest in the underlying or deliverable cash market security.

Currency forwards & spot FX.

Total return swaps – only types that are pre-approved by ERS Staff are permitted

(both long and short).

U.S. government agency floating rate notes – only types that are pre-approved by ERS

Staff are permitted.

Futures contracts must be CTFC (Commodity Futures Trading Commission) approved and

exchange traded.

Options must be exchange traded.

All counterparties must be rated investment grade as determined by at least one major

rating agency. Counterparties to OTC traded instruments (e.g. forwards) must be rated

investment grade (A-) or better as determined by at least one major rating agency.

Manager may purchase back options in order to close out positions.

Cross-hedging is permitted.

On an annual basis, all investment managers shall provide a summary of the derivatives

used and the reasons for their use. This summary shall be the basis for verification that the

investment managers are generally complying with the objectives and constraints of the

investment policy. The investment consultant shall elicit responses on each manager’s

policy in the form of a letter.

On a daily basis the custodian bank shall examine all manager derivatives purchases for

prohibited derivatives. Should any prohibited derivatives be found, the custodian bank

should promptly notify ERS Staff and instruct the manager to sell the prohibited

derivatives. The custodian bank will also value and monitor all derivatives and the trades

from which they emanate.


APPENDIX

A P P E N D I X

S E C T I O N S: A-D


APPENDIX

TABLE OF CONTENTS

Appendix

STATUTES ................................................................................................................................................ A

RISK FACTOR DEFINITIONS ............................................................................................................... B

MANAGER STYLE GROUPS ................................................................................................................. C

GLOSSARY OF INVESTMENT TERMS ............................................................................................... D

NOTE:

The information contained in Appendices B, C, and D are included in this Manual solely for use as an

educational guide for Trustees and Staff in their decision-making process. Appendices B, C, and D are not

part of the Board’s Investment Policy, Guidelines, and Procedures manual. The Board’s adopted policies

and procedures are the sole governing instruments.


APPENDIX A PAGE | 1

Appendix A

Statutes

CHAPTER 88:

HAWAI‘I REVISED STATUTES AS AMENDED 2014

§88-119 Investments. Investments may be made in:

(1) Real estate loans and mortgages. Obligations (as defined in section 431:6-101) of any of the

following classes:

(A) Obligations secured by mortgages of nonprofit corporations desiring to build

multirental units (ten units or more) subject to control of the government for

occupancy by families displaced as a result of government action;

(B) Obligations secured by mortgages insured by the Federal Housing Administration;

(C) Obligations for the repayment of home loans made under the Servicemen's

Readjustment Act of 1944 or under Title II of the National Housing Act;

(D) Other obligations secured by first mortgages on unencumbered improved real estate

owned in fee simple; provided that the amount of the obligation at the time

investment is made therein shall not exceed eighty per cent of the value of the real

estate and improvements mortgaged to secure it, and except that the amount of the

obligation at the time investment is made therein may exceed eighty per cent but no

more than ninety per cent of the value of the real estate and improvements mortgaged

to secure it; provided further that the obligation is insured or guaranteed against

default or loss under a mortgage insurance policy issued by a casualty insurance

company licensed to do business in the State. The coverage provided by the insurer

shall be sufficient to reduce the system's exposure to not more than eighty per cent

of the value of the real estate and improvements mortgaged to secure it. The

insurance coverage shall remain in force until the principal amount of the obligation

is reduced to eighty per cent of the market value of the real estate and improvements

mortgaged to secure it, at which time the coverage shall be subject to cancellation

solely at the option of the board. Real estate shall not be deemed to be encumbered

within the meaning of this subparagraph by reason of the existence of any of the

restrictions, charges, or claims described in section 431:6-308;

(E) Other obligations secured by first mortgages of leasehold interests in improved real

estate; provided that:

(i) Each leasehold interest at the time shall have a current term extending at least

two years beyond the stated maturity of the obligation it secures; and

(ii) The amount of the obligation at the time investment is made therein shall not

exceed eighty per cent of the value of the respective leasehold interest and

improvements, and except that the amount of the obligation at the time

investment is made therein may exceed eighty per cent but no more than ninety

per cent of the value of the leasehold interest and improvements mortgaged to

secure it; provided further that the obligation is insured or guaranteed against

default or loss under a mortgage insurance policy issued by a casualty


APPENDIX A PAGE | 2

insurance company licensed to do business in the State. The coverage

provided by the insurer shall be sufficient to reduce the system's exposure to

not more than eighty per cent of the value of the leasehold interest and

improvements mortgaged to secure it. The insurance coverage shall remain in

force until the principal amount of the obligation is reduced to eighty per cent

of the market value of the leasehold interest and improvements mortgaged to

secure it, at which time the coverage shall be subject to cancellation solely at

the option of the board;

(F) Obligations for the repayment of home loans guaranteed by the department of

Hawaiian home lands pursuant to section 214(b) of the Hawaiian Homes

Commission Act, 1920; and

G) Obligations secured by second mortgages on improved real estate for which the

mortgagor procures a second mortgage on the improved real estate for the purpose

of acquiring the leaseholder's fee simple interest in the improved real estate; provided

that any prior mortgage shall not contain provisions that might jeopardize the

security position of the retirement system or the borrower's ability to repay the

mortgage loan.

The board may retain the real estate, including leasehold interests therein, as it may

acquire by foreclosure of mortgages or in enforcement of security, or as may be

conveyed to it in satisfaction of debts previously contracted; provided that all the real

estate, other than leasehold interests, shall be sold within five years after acquiring

the same, subject to extension by the governor for additional periods not exceeding

five years each, and that all the leasehold interests shall be sold within one year after

acquiring the same, subject to extension by the governor for additional periods not

exceeding one year each;

(2) Government obligations, etc. Obligations of any of the following classes:

(A) Obligations issued or guaranteed as to principal and interest by the United States or

by any state thereof or by any municipal or political subdivision or school district of

any of the foregoing; provided that principal of and interest on the obligations are

payable in currency of the United States; or sovereign debt instruments issued by

agencies of, or guaranteed by foreign governments;

(B) Revenue bonds, whether or not permitted by any other provision hereof, of the State

or any municipal or political subdivision thereof, including the board of water supply

of the city and county of Honolulu, and street or improvement district bonds of any

district or project in the State; and

(C) Obligations issued or guaranteed by any federal home loan bank, including

consolidated federal home loan bank obligations, the Home Owner's Loan

Corporation, the Federal National Mortgage Association, or the Small Business

Administration;

(3) Corporate obligations. Below investment grade or nonrated debt instruments, foreign or

domestic, in accordance with investment guidelines adopted by the board;

(4) Preferred and common stocks. Shares of preferred or common stock of any corporation created

or existing under the laws of the United States or of any state or district thereof or of any

country;


APPENDIX A PAGE | 3

(5) Obligations eligible by law for purchase in the open market by federal reserve banks;

(6) Obligations issued or guaranteed by the International Bank for Reconstruction and

Development, the Inter-American Development Bank, the Asian Development Bank, or the

African Development Bank;

(7) Obligations secured by collateral consisting of any of the securities or stock listed above and

worth at the time the investment is made at least fifteen per cent more than the amount of the

respective obligations;

(8) Insurance company obligations. Contracts and agreements supplemental thereto providing for

participation in one or more accounts of a life insurance company authorized to do business in

Hawai‘i, including its separate accounts, and whether the investments allocated thereto are

comprised of stocks or other securities or of real or personal property or interests therein;

(9) Interests in real property. Interests in improved or productive real property in which, in the

informed opinion of the board, it is prudent to invest funds of the system. For purposes of this

paragraph, "real property" includes any property treated as real property either by local law or

for federal income tax purposes. Investments in improved or productive real property may be

made directly or through pooled funds, including common or collective trust funds of banks

and trust companies, group or unit trusts, limited partnerships, limited liability companies,

investment trusts, title-holding corporations recognized under section 501(c) of the Internal

Revenue Code of 1986, as amended, similar entities that would protect the system's interest,

and other pooled funds invested on behalf of the system by investment managers retained by

the system;

(10) Other securities and futures contracts. Securities and futures contracts in which in the informed

opinion of the board, it is prudent to invest funds of the system, including currency, interest

rate, bond, and stock index futures contracts and options on the contracts to hedge against

anticipated changes in currencies, interest rates, and bond and stock prices that might otherwise

have an adverse effect upon the value of the system's securities portfolios; covered put and call

options on securities; and stock; whether or not the securities, stock, futures contracts, or

options on futures are expressly authorized by or qualify under the foregoing paragraphs, and

notwithstanding any limitation of any of the foregoing paragraphs (including paragraph (4));

and

(11) Private placements. Investments in institutional blind pool limited partnerships, limited

liability companies, or direct investments that make private debt and equity investments in

privately held companies, including but not limited to investments in Hawai‘i high technology

businesses or venture capital investments that, in the informed opinion of the board, are

appropriate to invest funds of the system. In evaluating venture capital investments, the board

shall consider, among other things, the impact an investment may have on job creation in

Hawai‘i and on the state economy. The board shall report annually to the legislature on any

Hawai‘i venture capital investments it has made; provided that if the board determines it is not

prudent to invest in any Hawai‘i venture capital investments the board shall report the rationale

for the decision. The board, by January 1, 2008, shall develop criteria to determine the amount

of funds that may be prudently invested in Hawai‘i private placement investments. [L 1925, c

55, pt of §7; RL 1935, pt of §7926; am L 1935, c 156, §1; am L 1939, c 5, pt of §1; am L 1941,

c 50, §1 and c 61, §1; RL 1945, §710, subs 2; am L 1947, c 233, §1; am L 1949, c 297, §1; am

L Sp 1949, c 27, §1; am L 1951, c 56, §1; am L 1955, c 270, §§1, 2; RL 1955, §6-75; am L

1959, c 81, §1, c 144, §1, and c 175, §1; am L 1961, c 111, §1; am L 1965, c 222, §11; am L

1967, c 166, §§1, 2; HRS §88-110; am L 1969, c 107, §1, c 110, pt of §1, and c 159, §1; am L

1970, c 89, §§1 to 3; am L 1974, c 177, §1; am L 1977, c 83, §1; am L 1978, c 11, §2; am L


APPENDIX A PAGE | 4

1981, c 129, §1; am L 1983, c 105, §1; am L 1986, c 71, §1 and c 77, §2; am L 1987, c 114,

§1; am L 1990, c 34, §8; am L 1991, c 17, §1; am L 1998, c 151, §21; am L 1999, c 168, §1;

am L 2000, c 297, §12; am L 2006, c 169, §21; am L 2007, c 260, §2]

§88-119.5 Investment guidelines. Notwithstanding any other law to the contrary, real estate loans and

mortgages made pursuant to section 88-119(1)(D) and (E) shall be in accordance with conditions and

restrictions set forth by the board of trustees; provided that the board may establish the minimum and

maximum loan amounts and interest rates for these real estate loans and mortgages by motion, at any duly

noticed meeting of the board. The board of trustees, subject to chapter 91, shall adopt, amend, and repeal

rules having the force of and effect of law to implement all provisions of this section other than those

relating to loan amounts and interest rates for its real estate loans and mortgages. [L 1982, c 165, §3; am L

1991, c 17, §2; am L 1998, c 151, §22]

§88-120 Service charges. The board of trustees may pay out of any of the several funds held for

investment, a reasonable amount to any person for servicing and handling of mortgages purchased by the

board or for supplying investment advisory or consultative services; and to meet such other costs incident

to the prudent investment of system funds as the board may approve.

§88-121 Power to make agreements to protect securities on reorganization or otherwise. Anything

in this part to the contrary notwithstanding, the board of trustees may enter into an agreement or agreements

for the purpose of protecting the interests of the system in securities held by the system, or for the purpose

of reorganization of a corporation which issued securities so held, and deposit of securities there under with

a committee or depositories appointed under the agreement, but the agreement and deposit must first be

approved in writing by a majority of the members of the board with a statement of their reasons for such

approval. The board may accept corporate stock or bonds or other securities, which may be distributed

pursuant to any such agreement approved as aforesaid or to any plan or reorganization approved in writing

by a majority of the members of the board with a statement of their reasons for such approval. But if

securities so received consist in whole or in part of stock in any corporation or of bonds or obligations

which are not secured by adequate collateral security or where less than two-thirds of the total value of the

required collateral security therefore consist of collateral other than stock, then any stock and any such bond

or obligation so received shall be disposed of within five years from the time of acquisition or before

expiration of such further period or periods of time as may be fixed in writing for that purpose by the

governor.

§88-121.5. Power to enter into security loan agreements. Anything in this part to the contrary

notwithstanding, the board of trustees may enter into an agreement or agreements with a financially

responsible stock or bond brokerage firm, bank, or similar financial institution (“borrower”) authorized to

do business under the laws of any state or the United States, for the purpose of lending to the borrower

securities held by the system, subject to the following conditions:

(1) The securities shall be loaned to the borrower for a period not to exceed one year;

(2) At the termination of the loan period, the borrower shall deliver to the board of trustees

certificates for identical securities which are of the same class and issue as the loaned

securities;

(3) For the protection of the system, the borrower shall deliver to the board of trustees or its

agent, collateral in the form of cash, letters of credit, bonds, or other interest-bearing notes

and obligations of the United States or federal instrumentalities which are eligible for

investment by the board of trustees, in an amount not less than one hundred two percent of

the market value of the loaned securities, as determined by the board of trustees. The

system shall have a security interest in the collateral to secure borrower’s obligations under

the agreement. The board of trustees shall not be obligated to return the collateral or any


APPENDIX A PAGE | 5

part thereof to the borrower, except upon borrower’s delivery to the board or its agent of

securities identical to the loaned securities, as provided in paragraph (2). The board of

trustees or its designated agent shall monitor the market value of the loaned securities daily,

and if, on any business day, the amount of the collateral deposited by the borrower is less

than one hundred two percent of the market value of the loaned securities on that day, the

borrower shall immediately deposit with the board or its agent additional collateral in the

form of cash, letters of credit, bonds, or other interest-bearing notes and obligations of the

United States or federal instrumentalities which are eligible for investment by the board of

trustees. Such additional collateral, together with the collateral previously on deposit, shall

be in an amount not less than one hundred two percent of the market value of the loaned

securities at the time of such deposit;

(4) The board of trustees, at its election, may use or invest any collateral delivered by a

borrower to the board or its agent pursuant to the agreement, and any income and profits

earned on the collateral shall be retained for the benefit of the system. Any investment of

the collateral shall be subject to section 88-119;

(5) Until the termination of the loan, the borrower may securities, including the right to transfer

the loaned securities to others and vote or otherwise consent as a holder of such securities;

provided that the borrower shall exercise all the incidents of ownership of loaned, be

obligated to the board of trustees for all dividends and distributions made with respect to

the loaned securities during the period of the agreement, including, without limitation, cash,

stock or property dividends or distributions, interest payments, and subscription rights;

(6) In the event that the borrower, at the termination of the loan period, fails to deliver to the

board of trustees certificates for identical securities which are of the same class and issue

as the loaned securities, the borrowers shall forfeit to the system the collateral deposited.

(L 1981, c 212, §1)


APPENDIX B PAGE | 1

Appendix B

Risk Factor Definitions

Growth Risk - Risk related to uncertainties associated with the future growth path of a society’s economy,

and in particular, Gross Domestic Product (GDP) and corporate profitability. In general, economic growth

is measured by the real (inflation-adjusted) growth rate of a society’s GDP or per capita real GDP growth

rate. Since many types of investments are dependent on the growth rate of an economy, other measures

can be used to determine an investment market’s sensitivity to economic growth uncertainties. Such

measures might include: VIX (a measure of equity market uncertainty), credit spreads (high-yield bonds

and/or investment-grade bonds), and/or changes in the dispersion of economists’ GDP growth estimates.

(synonym(s): economic growth risk)

Inflation Risk - The uncertainty over the future real value (after inflation) of your investment. This is the

risk that inflation will undermine the performance of your investment and that it will lose purchasing power

over time.

Interest Rate Risk - The variability and/or uncertainty of interest rate changes over time. There are various

dimensions of interest changes, including changes in the level of yields, changes in the term structure of

interest rates (the yield curve), and changes to a portfolio’s general sensitivity to interest rates changes

(duration and convexity).

Leverage Risk - Societal leverage risk is reflected by both the amount of total debt of a society (government

debt plus individual debt plus corporate debt) and the tightness or looseness of the terms and conditions

associated with such debt. If debt is shrinking and terms are relatively stringent, then leverage risk is

declining. If debt is increasing and terms are loosening and/or becoming more accommodating, then

leverage risk is increasing.

Liquidity Risk - The potential that the trading volume of a market or a specific investment or security will

freeze up, leaving investors with no opportunity (or at least extremely limited opportunity) to exit an

investment at a market-determined price. In such cases, investors who must liquidate such investments

quickly will likely confront only liquidation options that require a substantial sacrifice of the investment’s

value.

Regulatory Risk- Uncertainty in relation to the geopolitical environment, as analyzed and ranked by the

Economist Intelligence Unit, a subsidiary of The Economist publishing group out of London.


APPENDIX C PAGE | 1

Appendix C

Manager Style Groups

Domestic Equity Management Style Groups

The Equity management style groups that follow are maintained in two separate databases; one exclusively

for open-end mutual funds with the indicated style and one for separate account investment manager

products with the indicated style.

Aggressive Growth – Managers who invest in growth securities with significantly higher risk/return

expectations than the broader market. Sometimes make concentrated “bets” by selecting a small number

of securities or by investing in only a few specific sectors. Selects from companies with market

capitalization significantly below the broader market. Invests in companies with P/E ratios, Price-to-Book

values, and Growth-in-Earnings values above the broader market. The companies typically have zero

dividends or dividend yields below the broader market. Invests in securities which exhibit greater volatility

than the broad market as measured by the securities’ Beta and Standard Deviation values.

Contrarian – Managers who invest in stocks that are out of favor or which have little current market

interest, on the premise that gain will be realized when they return to favor. Sometimes makes concentrated

“bets” by selecting a small number of securities or by investing in only a few specific sectors. Invests in

companies with Return-on-Assets values, Return-on-Equity values, Growth-in-Earnings values, and

Growth-in-Dividend values below the broad market. Chooses securities that, due to their contrary status,

do not move with the broader market, as measured by a low Beta and significant non-market risk.

Core – Managers whose portfolio holdings and characteristics are similar to that of the broader market as

represented by the Standard & Poor’s 500 Index, with the objective of adding value over and above the

index, typically from sector or issue selection. The core portfolio exhibits similar risk characteristics to

the broad market as measured by low residual risk with Beta and R-Squared values close to 1.00.

Large Cap Growth – Managers who invest mainly in large companies that are expected to have above

average prospects for long-term growth in earnings and profitability. Future growth prospects take

precedence over valuation levels in the stock selection process. Invests in companies with P/E ratios, Price-

to-Book values, Return-on-Assets values, and Growth-in-Earnings values above the broader market. The

companies typically have zero dividends or dividend yields below the broader market. Invests in securities

which exhibit greater volatility than the broader market as measured by the securities’ Beta and Standard

Deviation. The Growth Style Group is composed of two Growth Style sub-groups; the Growth (Sector

Rotator) Style Group and the Growth (Stock Selection) Style Group.

Large Cap Value – Managers who invest in predominantly large capitalization companies believed to be

currently undervalued in the general market. The companies are expected to have a near-term earnings

rebound and eventual realization of expected value. Valuation issues take precedence over near term

earnings prospects in the stock selection process. Invests in companies with P/E ratios, and Price-to-Book

values below the broader market. Usually exhibits lower risk than the broader market as measured by the

Beta and Standard Deviation. The Value Style Group consists of the Value (Bottom Up) Style Group and

the Value (Top Down) Style Group.

Middle Capitalization – Managers who invest primarily in mid-range companies with market

capitalizations between core equity companies and small capitalization companies. The average market

capitalization is approximately $3 billion. Invests in securities with greater volatility than the broader

market as measured by the risk statistics Beta and Standard Deviation. The Middle Capitalization Style

Group consists of the Middle Capitalization Growth Equity and the Middle Capitalization Value Equity

Style Groups.


APPENDIX C PAGE | 2

Middle Capitalization (Growth) – Managers who invest primarily in mid-range companies that are

expected to have above average prospects for long-term growth in earnings and profitability. Future growth

prospects take precedence over valuation levels in the stock selection process. The average market

capitalization is approximately $3 billion with market capitalizations between core equity companies and

small capitalization companies. Invests in companies with P/E ratios, Price-to Book values, and Growth-

in Earnings values above the broader market as well as the middle capitalization market segment. Invests

in securities with greater volatility than the broader market and the middle capitalization segment as

measured by the risk statistics Beta and Standard Deviation.

Middle Capitalization (Value) – Managers who invest primarily in mid-range companies believed to be

currently undervalued in the general market. Valuation issues take precedence over near term earnings

prospects in the stock selection process. The average market capitalization is approximately $3 billion with

market capitalizations between core equity companies and small capitalization companies. Invests in

companies with P/E ratios, Return-on-Equity values, and Price-to-Book values below the broader market

and the middle capitalization segment. Invests in securities with risk/reward profiles in the lower risk range

of the medium capitalization market.

Sector Rotation – Managers who identify sectors of the economy that show the best potential for

investment, and then target markets and firms for investment within the selected sectors according to

fundamental investment criteria. Sector weighting takes precedence over individual security selection in

the investment process.

Small Capitalization – Managers who invest in companies with relatively small capitalization. The

average market capitalization is approximately $400 million. The companies typically have zero dividends

or dividend yields below the broader market. The securities exhibit greater volatility than the broader

market as measured by the risk statistics Beta and Standard Deviation. The Small Capitalization Style

Group consists of the Small Capitalization (Growth) Style Group and the Small Capitalization(Value) Style

Group.

Small Capitalization (Growth) – Managers who invest mainly in small companies that are expected to

have above average prospects for long-term growth in earnings and profitability. Future growth prospects

take precedence over valuation levels in the stock selection process. Invests in companies with P/E ratios,

Price-to Book values, and Growth-in Earnings values above the broader market as well as the small

capitalization market segment. The companies typically have zero dividends or dividend yields below the

broader market. The securities exhibit greater volatility than the broader market as well as the small

capitalization market segment as measured by the risk statistics values Beta and Standard Deviation.

Small Capitalization (Value) – Managers who invest in small capitalization companies that are believed

to be currently undervalued in the general market. Valuation issues take precedence over near term earnings

prospects in the stock selection process. The companies are expected to have a near-term earnings rebound

and eventual realization of expected value. Invests in companies with P/E ratios, Return-on-Equity values,

and Price-to-Book values below the broader market as well as the small capitalization market segment.

Invests in securities with dividend yields in the high range for the small capitalization market. Invests in

securities with risk/reward profiles in the lower risk range of the small capitalization market.

Yield – Managers whose primary objective is a high current dividend yield. Invests in companies with

Price-to-Book values and Growth-in-Earnings values below the broader market. Invests in securities with

dividend yields above the broader market. Invests in securities with significantly lower volatility than the

broader market as measured by risk statistics values for Beta and Standard Deviation.

Fixed-Income Management Style Groups


APPENDIX C PAGE | 3

The fixed-income management style groups that follow are maintained in two separate databases; one

exclusively for open-end mutual funds with the indicated style and one for separate account investment

manager products with the indicated style.

Mortgage – Managers who invest primarily in mortgage-backed securities including agency (FHLMC,

GNMA, FNMA) and private issue pass-throughs, asset-backed securities, and mortgage derivatives

(REMICS/CMOs, IOs, POs). Funds may also contain a small percentage of U.S. Treasuries.

Active Cash – Managers whose objective is to achieve a maximum return on short-term financial

instruments through active management. The average portfolio duration is typically less than one year.

Active Duration – Managers who aggressively employ interest rate anticipation in setting portfolio

duration. Portfolios are actively managed so that large changes in duration are made in anticipation of

interest rate in hopes of profiting from downward rate movements and minimizing losses from upward rate

movements.

Convertible Bond – Managers who invest in convertible bonds. Convertible bonds offer the downside

floor price of a “straight” bond while potentially allowing the holder to share in price appreciation of the

underlying common stock. This conversion feature makes it possible for the bondholder to convert the bond

to shares of the issuer’s common stock.

Core Bond – Managers who construct portfolios to approximate the investment results of the Barclays

Capital Government/Corporate Bond Index or the Barclays Capital Aggregate Bond Index with a modest

amount of variability in duration around the index. The objective is to achieve value added from sector

and/or issue selection.

Core Plus – Active managers, benchmarked against the broad market (i.e. Barclays Capital Aggregate

Index), whose objective is to add value by tactically allocating significant portions of their portfolios among

non-benchmark sectors (e.g. high yield corporates, non-US$ bonds, etc.) while maintaining majority

exposure similar to the broad market. The median tendency of allocation between the two determinant

sectors, high yield and non-US$ bonds, is 10% and 5% respectively. In addition, municipals, CMBS,

convertibles and others are marginally utilized by core plus managers to add value.

Defensive – Managers whose objective is to minimize interest rate risk by investing predominantly in short

to intermediate term securities. The average portfolio duration and risk/return profile is similar to that of

the Merrill Lynch 1-3 Year Bond Index.

Extended Maturity – Managers whose average portfolio duration is significantly greater than that of the

Barclays Capital Government/Corporate Bond Index. These portfolios exhibit risk/return characteristics

similar to the long-bond portion of the Barclays Capital Government/Corporate Index, called the Barclays

Capital Government/Corporate Long Bond Index. Variations in bond portfolio characteristics are made to

enhance performance results. This results in an aggressive risk/return profile that embraces interest rate

risk in search of both high yields as well as capital gains.

High Yield – Managers whose investment objective is to obtain high current income by investing primarily

in non-investment grade fixed-income securities. Due to the increased level of default risk, security

selection focuses on credit-risk analysis.

Intermediate – Managers whose objective is to lower interest rate risk while maintaining reasonable yield

levels by investing primarily in intermediate term securities. The average portfolio duration and risk/return

profile is similar to that of the Barclays Capital Intermediate Government/Corporate Bond Index.


APPENDIX C PAGE | 4

Money Market – Open-end mutual funds that invest in low-risk, highly liquid, short-term financial

instruments and whose net asset value is kept stable at 1$ per share. The average portfolio maturity is 30

to 60 days.

International Equity Management Style Groups

The International Equity Management Style Groups that follow are maintained in two separate databases;

one exclusively for open-end mutual funds with the indicated style and one for separate account investment

manager products with the indicated style. All International Equity Style Groups exclude pure index funds

and regional funds (outside of regional style groups) in favor of actively managed, well-diversified

products.

Developed Markets – Managers who invest predominantly in well developed markets (i.e. G-20 nations)

in the regions of Europe, Australia, the Far East, and Canada. The objective of adding value over and above

the index is achieved through stock selection and/or changes in the weighting of individual countries versus

the index. These portfolios will exhibit risk/return portfolios similar to the MSCI World ex US ND Index.

Emerging Markets –Managers whose well-diversified portfolio holdings are mostly large holdings in

emerging countries, as characterized by the countries within the MSCI Emerging Markets Free Index. The

objective of adding value over and above the MSCI Emerging Markets Free Index is achieved through

stock selection and/or changes in the weighting of individual countries versus the index. These portfolios

are characterized by aggressive risk/return profiles that generate high volatility in search of high returns.

Bottom Up/Stock Selection – Managers who primarily emphasize stock selection in their portfolio

construction. The country weighting process is mainly a by-product of the stock selection decision, or can

be passively set according to the index country weights.

Core – Managers whose well-diversified portfolio holdings are mostly large issues in developed countries

with liquid markets, resulting in characteristics similar to that of an index such as the Morgan Stanley

Capital International(MSCI) EAFE Index. The objective of adding value over and above the index, is

achieved through stock selection and/or changes in the weighting of individual countries versus the index.

Europe – Managers who invest predominantly in the well developed stock markets of Europe. These

products will exhibit risk/return profiles similar to the MSCI Europe Index.

Japan – Managers who invest predominantly in the equity of companies in Japan.

Pacific Basin – Managers who invest predominantly in Pacific Basin equities. Countries include Japan,

Hong Kong, Singapore, Malaysia, Australia, and New Zealand. These products will exhibit risk/return

profiles similar to the MSCI Pacific Index.

Pacific Rim – Managers who invest predominantly in Pacific Basin equities excluding Japan. Countries

include Hong Kong, Singapore, Malaysia, Australia, and New Zealand. These products will exhibit

risk/return profiles similar to the MSCI Pacific ex-Japan Index.

Small Capitalization – Managers who invest in international companies with relatively small

capitalization. The companies typically have zero dividends or dividend yields below the broader market.

The securities exhibit greater volatility than the broader market as measured by the risk statistics Beta and

Standard Deviation.

Top Down/Country Allocator – Managers who attempt to add value over an index such as the Morgan

Stanley Capital International (MSCI) EAFE Index by emphasizing macroeconomic analysis in selecting


APPENDIX C PAGE | 5

allocations in countries with above average gain prospects. Stock selection plays a secondary role in the

investment decision process, or can be passively matched to the index stock holdings within each country.

Global Equity Management Style Groups

Active Global Equity – Managers who invest in both foreign and domestic equity securities in varying

proportions. These products will exhibit risk/return profiles similar to the MSCI World Index.

Passive Global Equity – Managers who seek to replicate the performance and characteristics of the MSCI

All Country World Index.

International Fixed-Income Management Style Groups

Global Fixed-Income – Managers who invest in both foreign and domestic fixed-income securities. These

funds seek to take advantage of international currency and interest rate movements, differing bond yields,

and/or international diversification.

Non-U.S. Fixed-Income – Managers who generally invest their assets only in non-U.S. fixed-income

securities. These funds seek to take advantage of international currency and interest rate movements, bond

yields, and/or international diversification.

Other Management Style Groups

CAI Total Real Estate Funds – This is not officially a style group. Rather it consists of 150 open and

closed-end commingled funds managed by real estate firms.


APPENDIX D PAGE | 1

Appendix D

Glossary Of Investment Terms

144(a) Securities -- 144a securities are in concept "semi-private placement securities," that are normally

traded by sophisticated institutional investors with limited financial information on the issuing company.

SEC rule 144a exempts issuers from SEC registration requirements. While not legally required to file with

the SEC, issuers normally do provide some sort of documentation describing the issue and financial

information about the issuing company.

Accrual Basis Accounting – As opposed to cash basis accounting, this values assets based upon accrued

changes in values, not actual cash flows. For example, dividends are included in the portfolio value (i.e.

accrued) as of the ex-dividend date, rather than the payment date (or the declaration date).

Active Management – A form of investment management which involves buying and selling financial

assets with the objective of earning positive risk-adjusted returns.

Adjusted R-Squared - The R-squared measure (see R-squared definition) adjusted for additional errors

associated with the overall model. The basic R-squared measure will increase simply by adding more

variables to the regression model. The Adjusted R-squared factors out this bias.

Alpha – The constant value in a statistical regression equation. Measures the added value by a manager.

A positive alpha indicates that a manager has performed better than its beta(s) would predict. In contrast,

a negative alpha indicates the fund has underperformed, given the expectations set by beta(s). Alpha is

always relative to the underlying factor model (e.g., single or multi-factor).

(synonym(s): added value)

Alternative Investments – These generally refer to institutional blind pool limited partnerships/LLCs

which make private debt and equity investments in privately held companies, as well as hedge funds and

other publicly traded derivatives-based strategies.

American Depository Receipts (ADRs) – Financial assets issued by U.S. banks that represent indirect

ownership of a certain number of equity shares in a foreign firm. ADRs are held on deposit in a bank in the

firm’s home country.

American Shares – American shares are securities issued in the US by a transfer agent acting on behalf of

a foreign firm.

Balanced Fund – An investment strategy which is a combination of equities and bonds.

Basis Point – 1/100th of 1%.

Behavioral Finance - A field of finance that proposes socio-/psychological-based theories to explain

investment market anomalies. Within behavioral finance, it is assumed that the information structure and

the characteristics of market participants systematically influence individuals' investment decisions as well

as market outcomes.

Benchmark Portfolio – A portfolio against which the investment performance of an investment manager

can be compared for the purpose of determining the value-added of the manager. A benchmark portfolio

must be of the same style as the manager, and in particular, similar in terms of risk.


APPENDIX D PAGE | 2

Best Execution – This is formally defined as the difference between the strike price (the price at which a

security is actually bought or sold) and the “fair market price,” which involves calculating opportunity costs

by examining the security price immediately after the trade is placed. Best execution occurs when the trade

involves no opportunity cost, for example when there is no increase in the price of a security shortly after

it is sold.

Beta - Measures a security’s or portfolio’s sensitivity to movements in a specific risk factor. Various factor

betas are determined simultaneously by utilizing a multiple regression model that utilizes return time series

for each relevant risk as the explanatory (or independent) variable and the portfolio/security return as the

explained (or dependent) variable. Each beta is the slope (or response) coefficient in the multi-linear

equation (the “β’s“ in the following equation: y= α + βixi + βiixii +…+ βnxn + ε). In a multiple regression,

individual factor betas can range from negative to positive, reflecting how a portfolio responds to the

behavior of each factor. Importantly, in basic multiple regression models, the beta for each factor assumes

that the other factor behaviors are held constant. Beta is most commonly used to refer to an investment’s

sensitivity to equity market risk per the CAPM or similar model (see below).

(synonym(s): exposure, factor exposure)

Boardroom Risk – The risk that Trustees will not ride out short term volatility (and therefore wind up

altering a sound long-term strategy) due to pressure put on them in their role as Trustees.

Bottom-up Analysis – An approach to valuing securities which first involves analyzing individual

companies, then the industry, and finally the economy and overall capital market.

Capital Asset Pricing Model (CAPM) – An equilibrium model of asset pricing which states that the

expected return of a security increases as the security’s sensitivity to the market (i.e. beta) increases. That

is, as the expected return of a security or portfolio increases (decreases), risk increases (decreases) as well.

Capitalization-weighted Market Index – A method of calculating a market index where the return of a

security (or group of securities) is weighted by the market value of the security (or group of securities)

relative to total value of all securities.

Carry - The difference between an investment with a lower expected absolute cost and an investment with

a higher expected return. For example, if U.S. Treasury Bills have an expected yield of 1% and 30-year

U.S. Treasury Bonds have an expected yield of 4%, then the amount of Carry is 3% (i.e., that amount earned

if you short (or borrow) U.S. Treasury Bills to finance a purchase of 30-year U.S. Treasury Bonds).

Cash Sweep Accounts – A money market fund into which all new contributions, stock dividend income

and bond interest income is placed (“swept”) for a certain period of time. At regular intervals, or when

rebalancing is necessary, this cash is invested in assets in line with the strategic allocation stipulated in the

IPS.

CFA Institute – The CFA Institute is the umbrella organization for the two large investment management

advisers' groups, the Institute of Chartered Financial Analysts and the Financial Analysts Federation. This

organization administers the annual examinations for the CFA designation and also publishes industry

guidelines for performance measurement reporting and calculations. The CFA Institute instituted a

standardized performance reporting format on January 1, 1993.

Commodities - Any basic good exchanged during commerce, which includes goods traded on a commodity

exchange. Commodities are most often used as inputs in the production of other goods or services. The

quality of a given commodity may differ slightly, but it is essentially uniform across producers. When they

are traded on an exchange, commodities must also meet specified minimum standards, also known as a

basis grade. Some traditional examples of commodities include grains, gold, beef, oil, and natural gas.


APPENDIX D PAGE | 3

Commingled Fund – An investment fund which is similar to a mutual fund in that investors purchase and

redeem units that represent ownership in a pool of securities.

Commission Recapture – An agreement by which a plan sponsor earns credits based upon the amount of

brokerage commissions paid. These credits can be used for services which will benefit the plan, such as

consulting services, custodial fees, or hardware and software expenses.

Conditional VaR - A risk assessment technique often used to reduce the probability a portfolio will incur

large losses. This is performed by assessing the likelihood (at a specific confidence level) that a specific

loss will exceed the value at risk. Mathematically speaking, CVaR is derived by taking a weighted average

between the value at risk and losses exceeding the value at risk. This term is also known as "Mean Excess

Loss", "Mean Shortfall" and "Tail VaR".

Conditional Value at Risk was created to be an extension of Value at Risk (VaR). The VaR model allows

managers to limit the likelihood of incurring losses caused by certain types of risk - but not all risks. The

problem with relying solely on the VaR model is that the scope of risk assessed is limited, since the tail end

of the distribution of loss is not typically assessed. Therefore, if losses are incurred, the amount of the losses

will be substantial in value.

(synonym(s): downside risk, tail risk)

Convertible Bond – A bond which may, at the holder’s option, be exchanged for common stock.

Core Bond – A fixed income investment strategy which constructs portfolios to approximate the

investment results of the BC Government/Corporate Bond Index with a modest amount of variability in

duration around the index. The objective is to achieve value added from sector or issue selection.

Core Equity – An investment strategy where the portfolio’s characteristics are similar to that of the S&P

500 Index, with the objective of adding value over and above the index, typically from sector or issue

selection.

Correlation Coefficient – A statistical measure similar to covariance, in that it measures the mutual

variation between two variables. The correlation coefficient is bounded by the values -1 and +1.

Covariance – A statistical measure of the mutual variation between two variables.

Credit Risk - The risk of loss of principal or loss of a financial reward stemming from a borrower's failure

to repay a loan or otherwise meet a contractual obligation. Credit risk is typically measured by the yield

differentials between fixed income instruments (e.g., corporate bond yields versus Treasury bond yields;

high-yield corporate bond yields versus investment-grade corporate bond yields; etc.). Since credit

obligations are typically more senior in the corporate capital structure than equity, credit risk is lower or

higher depending on the amount of equity that supports the credit obligations. Since credit risk and equity

risk are thus linked, changes in the yields of credit instruments may very well indicate changes in the equity

risk of a corporation.

Currency Risk - The risk of an investment's value changing due to changes in currency exchange rates.

When a U.S. investor invests in another country, it must first convert its U.S. Dollars to the other country’s

currency. Once converted this non-U.S. currency can then purchase assets in that other country’s markets.

The value of those investments will fluctuate in local currency terms, but the value of local currency also

fluctuates in relation to the U.S. Dollar. This latter fluctuation relates directly to currency risk. If the U.S.

Dollar ends up with a higher value in relation to the other country’s currency, then value will have been

lost due to currency fluctuations regardless of how the investment is performing within its country market.

The opposite is also true if the U.S. Dollar ends up with a lower value versus the other country’s currency.

This phenomenon exists across all pairs of currencies across numerous countries.


APPENDIX D PAGE | 4

Current Yield – The annual dollar amount of coupon payments made by a bond divided by the bond’s

current market price.

Defensive – A fixed income investment strategy where the objective is to minimize interest rate risk by

investing only in short to intermediate term securities. The average portfolio maturity is typically two to

five years.

Derivative – A financial derivative is a security which derives its value from a more fundamental financial

security such as a stock or bond. For example, the value of a stock option depends upon the value from the

underlying stock. Because the stock option cannot exist without the underlying stock, the stock option is

derived from the stock itself.

Dividend Yield – The current annualized dividend paid on a share of common stock, expressed as a

percentage of the stock’s current market price.

Down Market Capture Ratio - The portion of the market’s performance that was captured by the manager

using only periods where the market return is negative. A down market capture of less than 100% is

considered desirable.

Duration – A measure of the average maturity of the stream of interest payments of a bond. The value of

a given bond is more sensitive to interest rate changes as duration increases, i.e. longer duration bonds have

greater interest rate volatility than shorter duration bonds.

Dollar-weighted Measurement – In calculating summary statistics, a process by which performance

measures are weighted by the dollar amounts of assets in each time period.

Earnings Per Share – A firm’s reported earnings divided by the number of its common shares outstanding.

Economically-targeted Investment – Investments where the goal is to target a certain economic activity,

sector or area in order to produce corollary benefits in addition to the main objective of earning a

competitive risk-adjusted rate of return.

Efficient Market – A theory which claims that a security’s market price equals its true investment value

at all times since all information is fully and immediately reflected in the market price.

Efficient Portfolio – A portfolio which offers maximum expected return for a given level of risk or

minimum risk for a given level of expected return.

Equity Beta - Measures a security’s or portfolio’s sensitivity to movements in the broad equity market.

The “broad equity market” can be defined from either a domestic or global perspective. Equity beta is often

determined by utilizing a simple regression model that utilizes an equity benchmark as the explanatory (or

independent) variable and the portfolio/security return as the explained (or dependent) variable. The Equity

Beta is the slope coefficient in the simple linear equation (“m” in the basic “y=mx+b” equation we all

learned in middle-school math class). In investment finance, the Equity Beta can range from negative to

positive, but typically ranges in value from -1.0 to 2.0. Equity Betas of reasonably diversified equity

portfolios are usually greater than 0.75.

ERISA – The Employee Retirement Security Act, signed into law in September 1974. ERISA established

a strict set of fiduciary responsibilities for corporate pension funds, and some states have adopted the ERISA

provisions for public plans. It is recommended that public pension plans use the ERISA regulations as

guidelines for managing the plan’s assets in a procedurally prudent manner.


APPENDIX D PAGE | 5

Eurobond – An international bond denominated in a currency other than that of the country where the bond

is issued.

Exchange Traded Funds (ETF’) – ETF’s are registered, open-ended unit investment trusts that invest in

a basket of stocks designed to track the performance of a given index. However, like a closed-end fund,

investors buy shares in ETF's from another shareholder on the open market rather than from a fund

company.

Exculpatory – A clause or set of regulations, for example the “safe harbor rules”, which generally frees

Trustees from responsibility and liability.

Extended Maturity – A fixed income investment strategy where average portfolio maturity is greater than

that of the Barclays Capital Government/Corporate Bond Index. Variations in bond portfolio characteristics

are made to enhance performance results.

Fiduciary – Indicates the relationship of trust and confidence where one person (the fiduciary) holds or

controls property for the benefit of another person. For example, the relationship between a Trustee and the

beneficiaries of the trust.

Fundamental Indexing – A process for building passive investment portfolios that utilizes measures of

company size not related to the price of a company’s stock, which is used when calculating the market

value of company. Company market values, in turn, are used to determine proportional weightings in “cap-

weighted” indices (the industry-standard practice). Proponents of fundamental indexing argue that cap-

weighted indices have significant biases toward momentum (or trending) risk. Weighting companies on

more stable fundamental factors can allow investors to avoid this bias. Detractors of fundamental indexing

argue that the construction rules of fundamental indexing simply lead to portfolios exhibiting other biases

(such as size and value biases).

Funding Risk – The risk that anticipated contributions to the plan will not be made.

Geometric Returns – A method of calculating returns which links portfolio results on a quarterly or

monthly basis. This method is best illustrated by an example, and a comparison to arithmetic returns, which

does not utilize a time link. Suppose a $100 portfolio returned +25% in the first quarter (ending value is

$125) but lost 20% in the second quarter (ending value is $100). Over the two quarters the return was 0%,

and the method of calculating the geometric return would indicate this. However, the arithmetic calculation

would simply average the two returns: (25%)(.5) + (20%)(.5) = +2.5%.

Global Equity – Managers who invest in both foreign and domestic equity securities but excludes regional

and index funds.

Going-in Yield - The expected yield-to-maturity on a portfolio going forward. When estimating a

regression model of a specific portfolio’s expected returns, the regression’s estimated constant term

(typically referred to as the equation’s “α” or “alpha” term) represents the going-in yield.

Growth Equity – Managers who invest in companies that are expected to have above average prospects

for long-term growth in earnings and profitability.

High Yield – A fixed income investment strategy where the objective is to obtain high current income by

investing in lower rated, higher default-risk fixed-income securities. As a result, security selection focuses

on credit risk analysis.

Index Fund – A passively managed investment in a diversified portfolio of financial assets designed to

mimic the performance of a specific market index.


APPENDIX D PAGE | 6

Interest Rate Risk – The uncertainty in the return on a bond caused by unanticipated changes in its value

due to changes in the market interest rate.

Intermediate – A fixed income investment strategy where the objective is to lower interest rate risk by

investing only in intermediate-term securities. The average portfolio maturity is typically five to seven

years.

Liquidity – In general, liquidity refers to the ease by which a financial asset can be converted into cash.

Liquidity is often more narrowly defined as the ability to sell an asset quickly without having to make a

substantial price concession.

Liquidity Risk – The risk that there will be insufficient cash to meet the fund’s disbursement and expense

requirements.

Lost Opportunity Risk – The risk that through inappropriate market timing strategies a fund’s portfolio

will miss long-run market opportunities.

Manager Search – The selection of specific managers following the manager structure.

Manager Structure – The identification of the type(s) of managers to be selected within each broad class

of assets.

Marked to the Market – The daily process of adjusting the value of a portfolio to reflect daily changes in

the market prices of the assets held in the portfolio.

Market Anomaly - An investment return distortion that contradicts broadly accepted financial theories

such as the Efficient Markets Hypothesis (EMH) and the Capital Asset Pricing Model (CAPM). For

example, the CAPM is a theoretical model that says stock returns (above the risk-free rate of return) are a

function of only two types of risk: (i) risk of the broad equity market and (ii) unique risk associated with

the company the stock represents. The CAPM indicates that, over time, incremental returns associated with

(ii) above should cancel out. Empirical evidence reveals, however, that such incremental returns are, in

fact, positive. This result indicates that a “market anomaly” exists and/or another risk factor needs to be

added to the CAPM to make it more robust.

Market Risk – See Systematic Risk.

Market Timing – A form of active management that shifts funds between strategic classes based on short-

term expectations of movements in the capital markets.

Momentum - The rate of increase/decrease of a security's price or volume. The idea of momentum in

securities is that their price is more likely to keep moving in the same direction than to change directions.

In technical analysis, momentum is considered an oscillator and is used to help identify trend lines. Once a

momentum trader sees acceleration in a stock's price, earnings or revenues, the trader will often take a long

or short position in the stock in the hope that its momentum will continue in either an upward or downward

direction. This strategy relies on short-term movements in a stock's price rather than fundamental value.

Money Markets – Financial markets in which financial assets with a maturity of less than one year are

traded.

Passive Management – For a given strategic class, the process of buying a diversified portfolio which

attempts to duplicate the overall performance of the strategic class (i.e. the relevant market index).


APPENDIX D PAGE | 7

Performance Attribution – The identification of the sources of returns for a security or portfolio over a

particular time period.

Preferred Stock – Preferred stocks actually behaves as a fixed-income investment because the dividend

payment is fixed. However, unlike bonds, the dividend payment is not legally binding.

Price-earnings Ratio – A firm’s current stock price divided by its earnings per share.

Private Placement – The direct sale of a newly issued security to one or a small number of large

institutional investors.

Proxy Voting – A written authorization given by a shareholder to someone else to vote his or her shares at

a stockholders annual or special meeting called to elect directors or for some other corporate purpose.

Purchasing Power Risk – The risk that a portfolio will earn a return less than the rate of inflation, i.e., a

negative real return.

Real Estate Investment Trust (REIT) – An investment fund whose objective is to hold real estate-related

assets, either through mortgages, construction and development loans, or equity interests.

Restatement Third, Trusts (Prudent Investor Rule) – A set of new and more specific standards for the

handling of the investment process by fiduciaries. These standards were adopted in 1992 and rely heavily

on modern investment theory.

Return On Equity – The earnings per share of a firm divided by the firm’s book value per share.

Risk Factors - Key elements that are most influential in explaining a security’s or portfolio’s return. In a

statistical modeling sense, they are the explanatory variables in a regression equation whose behaviors are

deemed to influence the behavior of the dependent (or explained) variable based upon fundamental

knowledge. Risk factors can be benchmarks or other more fundamental variables (such as GDP growth or

changes in the levels of certain interest rates).

Risk Premia - The return in excess of an opportunity cost (e.g., risk-free rate of return) or funding source

that an investment is expected to yield. An asset's risk premium is a form of compensation for investors

who tolerate the extra risk - compared to that of an opportunity cost/forgone option - in a given investment.

Risk-Adjusted Return - A concept that refines an investment's return by measuring how much risk is

involved in producing that return, which is generally expressed as a number or rating. Risk-adjusted returns

are applied to individual securities and investment funds and portfolios.

There are five principal risk measures: alpha, beta, r-squared, standard deviation and the Sharpe ratio. Each

risk measure is unique in how it measures risk. When comparing two or more potential investments, an

investor should always compare the same risk measures to each different investment in order to get a

relative performance perspective.

Roll Yield - The amount of return generated in a futures market that is achieved by rolling a short-term

contract into a longer-term contract and profiting from the convergence toward a higher spot price. Profiting

from roll yield is a common goal for many strategies used by traders in the futures market.

“Backwardation” occurs when a futures contract will trade at a higher price as it approaches expiration

compared to when the contract is farther away from expiration. Rolling into less expensive futures contracts

allows the trader to consistently profit from the rise in a futures' price as it nears expiration.


APPENDIX D PAGE | 8

The biggest risk to this strategy is that the market will shift to “contango” (opposite as backwardation). This

type of changing market has led to major losses by various hedge funds in the past.

R-squared (R2) – Formally called the coefficient of determination, this measures the overall strength or

“explanatory power” of a statistical relationship. In general, a higher R2 means a stronger statistical

relationship between the variables which have been estimated, and therefore more confidence in using the

estimation for decision-making.

Sharpe Ratio – This statistic is a commonly used measure of risk-adjusted return. It is calculated by

subtracting the "risk-free" return (usually 3 Month Treasury Bill) from the portfolio return and dividing the

resulting "excess return" by the portfolio's risk level (standard deviation). The result is a measure of return

gained per unit of risk taken. The higher the Sharpe ratio, the better the fund's historical risk-adjusted

performance.

(synonym(s): risk-adjusted return)

Skill - Associated with the ability to add value beyond simply tilting the portfolio toward one or more

systematic market factors (e.g., tilt toward small cap, value, or an economic sector). From a statistical

perspective, a portfolio will exhibit added value due to skill if its “α” or “alpha” term is positive after taking

into account all relevant “β’s” or “betas” (i.e., the contribution(s) associated with the tilt(s) toward certain

systematic factors). In addition, skill is associated with consistency of added value over time and typically

should be examined over multiple, independent time periods. Typically, evidence of true skill only

becomes apparent after several years of investment experience. Other qualitative factors associated with

skill include (i) the stability of an investment team, (ii) the integrity of the investment process, (iii) the scale

of the assets under management, etc.

(synonym(s): added value, alpha)

Small Capitalization – Managers who invest in equities of companies with relatively small capitalization.

The cut-off point for small capitalization varies from manager to manager, but on average targets firms with

capitalization of $200-$600 million.

Small Cap Effect - A theory that holds that smaller firms, or those companies with a small market

capitalization, outperform larger companies. Outperformance of stocks of smaller companies versus stocks

of larger companies typically exhibits itself over longer investment horizons. There can be extended

periods of time where the inverse condition exists (stocks of large companies outperform stocks of smaller

companies). Rationale for the existence of the Small Cap Effect often reflects the idea that such companies

exhibit various forms of business distress, on average, versus the average business conditions of larger

companies.

“Smart” Beta - Typically refers to a rules-based investment strategy that is largely passive in nature and

avoids the pitfalls of market capitalization-based indexes. For example, an investment strategy that simply

screens for high dividend stocks on a regular basis and adjusts the portfolio accordingly would be

considered a smart beta strategy. Other portfolio construction techniques that rely on basic company

fundamentals (e.g., fundamental indexing) would also be considered smart beta strategies. An important

pitfall of smart beta strategies is that, even though they are designed to eliminate certain biases associated

with market-cap weighting (e.g., mis-timed overweighting of momentum), they introduce other biases into

a portfolio (e.g., value bias, sector biases, etc.).

(synonym(s): fundamental indexing, “low-vol” equity)

Socially-targeted Investment – An investment which is undertaken based upon social, rather than purely

financial, guidelines.

Soft Dollars – The portion of a plan's commissions expense incurred in the buying and selling of securities

that is allocated through a directed brokerage arrangement for the purpose of acquiring goods or services


APPENDIX D PAGE | 9

for the benefit of the plan. In many soft dollar arrangements, the payment scheme is effected through a

brokerage affiliate of the investment consultant. Broker-investment consultants servicing smaller plans

receive commissions directly from the counseled account. Other soft dollar schemes are effected through

brokerages that, while acting as the clearing/transfer agent, also serve as the conduit for the payment of fees

between the primary parties to the directed fee arrangement.

Sortino Ratio - A measure of the portfolio’s excess return, relative to a target rate, divided by the portfolio’s

downside variance (semi standard deviation), relative to the target rate.

(synonym(s): downside risk-adjusted return)

Specific Risk – The part of a security’s total risk which is not related to movements in the market and

therefore can be diversified away.

Standard Deviation (and variance) – A statistical measure of portfolio risk. It reflects the average

deviation of the observations from their sample mean. Standard deviation is used as an estimate of risk

since it measure how wide the range of returns typically is. The wider the typical range of returns, the higher

the standard deviation of returns, and the higher the portfolio risk. If returns are normally distributed (i.e.

has a bell shaped curve distribution) then approximately 2/3 of the returns would occur within plus or minus

one standard deviation from the sample mean.

(synonym(s): volatility, total risk)

Strategic Allocation – The process of determining the optimal allocation of a fund’s portfolio among broad

strategic classes. Typically involves rebalancing back to the normal mix at specified time intervals

(quarterly) or when established tolerance bands (e.g., + and - 10%) are violated

Strategic Allocation Risk – The risk that a non-optimal strategic allocation will be undertaken which does

not meet the fund’s return and risk targets.

Systematic Risk – The part of a security’s total risk that is related to movements in the market and therefore

cannot be diversified away.

Tactical Allocation – Closely related to a strategy of market timing, this strategy uses certain indicators to

make adjustments in the proportions of a portfolio invested in stocks, bonds, and cash.

Term-to-maturity – The time remaining until a bond’s maturity date.

Time-weighted Return – A method of measuring the performance of a portfolio over a particular period

of time. It is the cumulative compounded rate of return of the portfolio, calculated on each date that cash

flow moves into or out of the portfolio.

Top-down Analysis – An approach to valuing equities which first looks at the economy and overall capital

market, then industries, and finally individual firms.

Treynor Ratio – The portfolio’s average excess return over a specified period divided by the beta relative

to its benchmark over the same time frame. This is used to measure the excess return per unit of systematic

risk taken.

Up Market Capture Ratio - The portion of the market’s performance that was captured by the manager

using only periods where the market return is positive. An up market capture of greater than 100% is

considered desirable.

Value at Risk (VaR) - A statistical technique used to measure and quantify the level of financial risk within

a firm or investment portfolio over a specific time frame. Value at risk is used by risk managers in order to


APPENDIX D PAGE | 10

measure and control the level of risk which the firm undertakes. The risk manager's job is to ensure that

risks are not taken beyond the level at which the firm can absorb the losses of a probable worst outcome.

Value at Risk is measured in three variables: the amount of potential loss, the probability of that amount of

loss, and the time frame. For example, a financial firm may determine that it has a 5% one-month value-at-

risk of at least $100 million. This means that there is a 5% chance that the firm could lose more than $100

million in any given month. Therefore, a minimum $100 million loss should be expected to occur once

every 20 months.

Value Effect - A theory that holds that value stocks outperform growth stocks. The significance of the

Value Effect has been empirically tested by several investment finance practitioners. Value stocks are those

stocks that have low market values in relation to their book value of equity and/or offer higher-than-average

dividends in relation to their market value. Growth stocks are those stocks of companies that exhibit higher-

than-average corporate earnings growth rates over specific periods of time.

Value Equity – Managers who invest in companies believed to be undervalued or possessing lower than

average price/earnings ratios, based on their potential for capital appreciation.

Volatility - A statistical measure of the dispersion of returns for a given security, portfolio, or market index.

Volatility can either be measured by using the standard deviation or variance between returns from that

same security, portfolio, or market index. Commonly, the higher the volatility, the riskier the investment.

(synonym(s): risk, variance, standard deviation)

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